Define each of the following terms: a. Weighted average cost of capital, WACC; after-tax cost of debt, r d (1 – T); after-tax cost of short-term debt, r std (1 – T) b. Cost of preferred stock , r ps ; cost of common equity (or cost of common stock), r s c. Target capital structure d. Flotation cost, F; cost of new external common equity, r e

Question

Want to see more full solutions like this?

Answer 1

Textbook Question

Chapter 11, Problem 1Q

Define each of the following terms:

a. Weighted average cost of capital, WACC; after-tax cost of debt, r_d(1 – T); after-tax cost of short-term debt, r_std(1 – T)
b. Cost of preferred stock, r_ps; cost of common equity (or cost of common stock), r_s
c. Target capital structure
d. Flotation cost, F; cost of new external common equity, r_e

a)

Expert Solution

Summary Introduction

To discuss: Weighted average cost of capital (WACC), after-tax cost of debt r_d (1-t) and after tax cost of short term debt r_std (1-t).

Explanation of Solution

Weighted average cost of capital is nothing but minimum (expected) required rate of return and it is also called as cut of rate. It includes cost of all sources like common stock, bonds in long term and preferred stock that are weighted proportionately while calculating weighted average cost of capital.

After tax cost of debt r_d (1-t), is the applicable cost to the company for new financing of debt. For this purpose, interest that accrues on debt is allowed as deduction for tax purposes.

If a company has short-term period debt with a cost of r_std, then it’s after tax cost is r_std (1-t), is the proper cost of debt.

b)

Expert Solution

Summary Introduction

To discuss: Cost of preferred cost (r_ps) and cost of common equity (r_s).

Explanation of Solution

Cost of preferred stock is nothing but the cost of issuing new preferred stock by company. For perpetual preferred, it is nothing but preferred dividend divided by net issue price.

Cost of common equity is nothing but the cost of equity obtained by selling new common stocks of a company. It is basically, the cost of retained earnings income adjusted for floating costs. Floating costs are incurred when the company issues new securities for the first time.

c)

Expert Solution

Summary Introduction

To discuss: Target capital structure.

Explanation of Solution

The target capital structure is nothing but the relative amount of debt, common equity and preferred stock that an organization desires. Calculation of weighted average cost of capital is totally based on these target weights.

d)

Expert Solution

Summary Introduction

To discuss: Flotation cost and cost of new external common equity.

Explanation of Solution

The concept of floatation cost is considered when a company issues a new security. This includes fees paid to investment bankers and other legal fees. The cost of new common equity is better than that of not unusual equity raised internally by reinvesting earnings. The projects financed with external equity must earn higher returns, since the projects must cover these flotation costs.

Want to see more full solutions like this?

Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Students have asked these similar questions

Moose Enterprises finds it is necessary to determine its marginal cost of capital. Moose’s current capital structure calls for 50 percent debt, 30 percent preferred stock, and 20 percent common equity. Initially, common equity will be in the form of retained earnings (Ke) and then new common stock (Kn). The costs of the various sources of financing are as follows: debt, 9.6 percent; preferred stock, 9 percent; retained earnings, 10 percent; and new common stock, 11.2 percent. a. What is the initial weighted average cost of capital? (Include debt, preferred stock, and common equity in the form of retained earnings, Ke.) b. If the firm has $18 million in retained earnings, at what size capital structure will the firm run out of retained earnings? c. What will the marginal cost of capital be immediately after that point? (Equity will remain at 20 percent of the capital structure, but will all be in the form of new common stock, Kn.) d. The 9.6 percent cost of debt referred to earlier…

7. Berkeley Farms wants to determine the minimum cost of capital point for the firm. Assume it is considering the following financial plans: Cost (aftertax) Weights Plan A Debt .................................. 4.0% 30% Preferred stock .................. 8.0 15 Common equity ................. 12.0 55 Plan B Debt .................................. 4.5% 40% Preferred stock .................. 8.5 15 Common equity ................. 13.0 45 Plan C Debt .................................. 5.0% 45% Preferred stock .................. 18.7 15 Common equity ................. 12.8 40 Plan D Debt .................................. 12.0% 50% Preferred stock .................. 19.2 15 Common equity ................. 14.5 35 a. Which of the four plans has the lowest weighted average cost of capital? Use the Kd (cost of debt) = Y(1 - T), Kp (Cost of preferred stock) = Dp/Pp - F, Ke = D1/P0 + g formulas or I will not understand.

Need use the Kd (cost of debt) = Y(1 - T), Kp (Cost of preferred stock) = Dp/Pp - F, Ke = D1/P0 + g formulas or I will not understand. Delta Corporation has the following capital structure: Cost Weighted (after-tax) Weights Cost Debt 8.1% 35% 2.84% Preferred stock (Kp) 9.6 5 .48 Common equity (Ke) (retained earnings) 10.1 60 6.06 Weighted average cost of capital (Ka) 9.38% a. If the firm has $18…

Answer 2

Textbook Question

Chapter 11, Problem 1Q

Define each of the following terms:

a. Weighted average cost of capital, WACC; after-tax cost of debt, r_d(1 – T); after-tax cost of short-term debt, r_std(1 – T)
b. Cost of preferred stock, r_ps; cost of common equity (or cost of common stock), r_s
c. Target capital structure
d. Flotation cost, F; cost of new external common equity, r_e

a)

Expert Solution

Summary Introduction

To discuss: Weighted average cost of capital (WACC), after-tax cost of debt r_d (1-t) and after tax cost of short term debt r_std (1-t).

Explanation of Solution

Weighted average cost of capital is nothing but minimum (expected) required rate of return and it is also called as cut of rate. It includes cost of all sources like common stock, bonds in long term and preferred stock that are weighted proportionately while calculating weighted average cost of capital.

After tax cost of debt r_d (1-t), is the applicable cost to the company for new financing of debt. For this purpose, interest that accrues on debt is allowed as deduction for tax purposes.

If a company has short-term period debt with a cost of r_std, then it’s after tax cost is r_std (1-t), is the proper cost of debt.

b)

Expert Solution

Summary Introduction

To discuss: Cost of preferred cost (r_ps) and cost of common equity (r_s).

Explanation of Solution

Cost of preferred stock is nothing but the cost of issuing new preferred stock by company. For perpetual preferred, it is nothing but preferred dividend divided by net issue price.

Cost of common equity is nothing but the cost of equity obtained by selling new common stocks of a company. It is basically, the cost of retained earnings income adjusted for floating costs. Floating costs are incurred when the company issues new securities for the first time.

c)

Expert Solution

Summary Introduction

To discuss: Target capital structure.

Explanation of Solution

The target capital structure is nothing but the relative amount of debt, common equity and preferred stock that an organization desires. Calculation of weighted average cost of capital is totally based on these target weights.

d)

Expert Solution

Summary Introduction

To discuss: Flotation cost and cost of new external common equity.

Explanation of Solution

The concept of floatation cost is considered when a company issues a new security. This includes fees paid to investment bankers and other legal fees. The cost of new common equity is better than that of not unusual equity raised internally by reinvesting earnings. The projects financed with external equity must earn higher returns, since the projects must cover these flotation costs.

Want to see more full solutions like this?

Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Answer 3

Textbook Question

Chapter 11, Problem 1Q

Define each of the following terms:

a. Weighted average cost of capital, WACC; after-tax cost of debt, r_d(1 – T); after-tax cost of short-term debt, r_std(1 – T)
b. Cost of preferred stock, r_ps; cost of common equity (or cost of common stock), r_s
c. Target capital structure
d. Flotation cost, F; cost of new external common equity, r_e

a)

Expert Solution

Summary Introduction

To discuss: Weighted average cost of capital (WACC), after-tax cost of debt r_d (1-t) and after tax cost of short term debt r_std (1-t).

Explanation of Solution

Weighted average cost of capital is nothing but minimum (expected) required rate of return and it is also called as cut of rate. It includes cost of all sources like common stock, bonds in long term and preferred stock that are weighted proportionately while calculating weighted average cost of capital.

After tax cost of debt r_d (1-t), is the applicable cost to the company for new financing of debt. For this purpose, interest that accrues on debt is allowed as deduction for tax purposes.

If a company has short-term period debt with a cost of r_std, then it’s after tax cost is r_std (1-t), is the proper cost of debt.

b)

Expert Solution

Summary Introduction

To discuss: Cost of preferred cost (r_ps) and cost of common equity (r_s).

Explanation of Solution

Cost of preferred stock is nothing but the cost of issuing new preferred stock by company. For perpetual preferred, it is nothing but preferred dividend divided by net issue price.

Cost of common equity is nothing but the cost of equity obtained by selling new common stocks of a company. It is basically, the cost of retained earnings income adjusted for floating costs. Floating costs are incurred when the company issues new securities for the first time.

c)

Expert Solution

Summary Introduction

To discuss: Target capital structure.

Explanation of Solution

The target capital structure is nothing but the relative amount of debt, common equity and preferred stock that an organization desires. Calculation of weighted average cost of capital is totally based on these target weights.

d)

Expert Solution

Summary Introduction

To discuss: Flotation cost and cost of new external common equity.

Explanation of Solution

The concept of floatation cost is considered when a company issues a new security. This includes fees paid to investment bankers and other legal fees. The cost of new common equity is better than that of not unusual equity raised internally by reinvesting earnings. The projects financed with external equity must earn higher returns, since the projects must cover these flotation costs.

Want to see more full solutions like this?

Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Answer 4

Textbook Question

Chapter 11, Problem 1Q

Define each of the following terms:

a. Weighted average cost of capital, WACC; after-tax cost of debt, r_d(1 – T); after-tax cost of short-term debt, r_std(1 – T)
b. Cost of preferred stock, r_ps; cost of common equity (or cost of common stock), r_s
c. Target capital structure
d. Flotation cost, F; cost of new external common equity, r_e

a)

Expert Solution

Summary Introduction

To discuss: Weighted average cost of capital (WACC), after-tax cost of debt r_d (1-t) and after tax cost of short term debt r_std (1-t).

Explanation of Solution

Weighted average cost of capital is nothing but minimum (expected) required rate of return and it is also called as cut of rate. It includes cost of all sources like common stock, bonds in long term and preferred stock that are weighted proportionately while calculating weighted average cost of capital.

After tax cost of debt r_d (1-t), is the applicable cost to the company for new financing of debt. For this purpose, interest that accrues on debt is allowed as deduction for tax purposes.

If a company has short-term period debt with a cost of r_std, then it’s after tax cost is r_std (1-t), is the proper cost of debt.

b)

Expert Solution

Summary Introduction

To discuss: Cost of preferred cost (r_ps) and cost of common equity (r_s).

Explanation of Solution

Cost of preferred stock is nothing but the cost of issuing new preferred stock by company. For perpetual preferred, it is nothing but preferred dividend divided by net issue price.

Cost of common equity is nothing but the cost of equity obtained by selling new common stocks of a company. It is basically, the cost of retained earnings income adjusted for floating costs. Floating costs are incurred when the company issues new securities for the first time.

c)

Expert Solution

Summary Introduction

To discuss: Target capital structure.

Explanation of Solution

The target capital structure is nothing but the relative amount of debt, common equity and preferred stock that an organization desires. Calculation of weighted average cost of capital is totally based on these target weights.

d)

Expert Solution

Summary Introduction

To discuss: Flotation cost and cost of new external common equity.

Explanation of Solution

The concept of floatation cost is considered when a company issues a new security. This includes fees paid to investment bankers and other legal fees. The cost of new common equity is better than that of not unusual equity raised internally by reinvesting earnings. The projects financed with external equity must earn higher returns, since the projects must cover these flotation costs.

Want to see more full solutions like this?

Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Answer 5

Textbook Question

Answer 6

Textbook Question

Answer 7

a)

Expert Solution

Summary Introduction

To discuss: Weighted average cost of capital (WACC), after-tax cost of debt r_d (1-t) and after tax cost of short term debt r_std (1-t).

Explanation of Solution

Weighted average cost of capital is nothing but minimum (expected) required rate of return and it is also called as cut of rate. It includes cost of all sources like common stock, bonds in long term and preferred stock that are weighted proportionately while calculating weighted average cost of capital.

After tax cost of debt r_d (1-t), is the applicable cost to the company for new financing of debt. For this purpose, interest that accrues on debt is allowed as deduction for tax purposes.

If a company has short-term period debt with a cost of r_std, then it’s after tax cost is r_std (1-t), is the proper cost of debt.

b)

Expert Solution

Summary Introduction

To discuss: Cost of preferred cost (r_ps) and cost of common equity (r_s).

Explanation of Solution

Cost of preferred stock is nothing but the cost of issuing new preferred stock by company. For perpetual preferred, it is nothing but preferred dividend divided by net issue price.

Cost of common equity is nothing but the cost of equity obtained by selling new common stocks of a company. It is basically, the cost of retained earnings income adjusted for floating costs. Floating costs are incurred when the company issues new securities for the first time.

c)

Expert Solution

Summary Introduction

To discuss: Target capital structure.

Explanation of Solution

The target capital structure is nothing but the relative amount of debt, common equity and preferred stock that an organization desires. Calculation of weighted average cost of capital is totally based on these target weights.

d)

Expert Solution

Summary Introduction

To discuss: Flotation cost and cost of new external common equity.

Explanation of Solution

The concept of floatation cost is considered when a company issues a new security. This includes fees paid to investment bankers and other legal fees. The cost of new common equity is better than that of not unusual equity raised internally by reinvesting earnings. The projects financed with external equity must earn higher returns, since the projects must cover these flotation costs.

Answer 8

a)

Expert Solution

Summary Introduction

To discuss: Weighted average cost of capital (WACC), after-tax cost of debt r_d (1-t) and after tax cost of short term debt r_std (1-t).

Explanation of Solution

Weighted average cost of capital is nothing but minimum (expected) required rate of return and it is also called as cut of rate. It includes cost of all sources like common stock, bonds in long term and preferred stock that are weighted proportionately while calculating weighted average cost of capital.

After tax cost of debt r_d (1-t), is the applicable cost to the company for new financing of debt. For this purpose, interest that accrues on debt is allowed as deduction for tax purposes.

If a company has short-term period debt with a cost of r_std, then it’s after tax cost is r_std (1-t), is the proper cost of debt.

Answer 9

a)

Expert Solution

Answer 10

a)

Expert Solution

Answer 11

Expert Solution

Answer 12

Summary Introduction

To discuss: Weighted average cost of capital (WACC), after-tax cost of debt r_d (1-t) and after tax cost of short term debt r_std (1-t).

Answer 13

Explanation of Solution

Weighted average cost of capital is nothing but minimum (expected) required rate of return and it is also called as cut of rate. It includes cost of all sources like common stock, bonds in long term and preferred stock that are weighted proportionately while calculating weighted average cost of capital.

After tax cost of debt r_d (1-t), is the applicable cost to the company for new financing of debt. For this purpose, interest that accrues on debt is allowed as deduction for tax purposes.

If a company has short-term period debt with a cost of r_std, then it’s after tax cost is r_std (1-t), is the proper cost of debt.

Answer 14

b)

Expert Solution

Summary Introduction

To discuss: Cost of preferred cost (r_ps) and cost of common equity (r_s).

Explanation of Solution

Cost of preferred stock is nothing but the cost of issuing new preferred stock by company. For perpetual preferred, it is nothing but preferred dividend divided by net issue price.

Cost of common equity is nothing but the cost of equity obtained by selling new common stocks of a company. It is basically, the cost of retained earnings income adjusted for floating costs. Floating costs are incurred when the company issues new securities for the first time.

Answer 15

b)

Expert Solution

Answer 16

b)

Expert Solution

Answer 17

Expert Solution

Answer 18

Summary Introduction

To discuss: Cost of preferred cost (r_ps) and cost of common equity (r_s).

Answer 19

Explanation of Solution

Cost of preferred stock is nothing but the cost of issuing new preferred stock by company. For perpetual preferred, it is nothing but preferred dividend divided by net issue price.

Cost of common equity is nothing but the cost of equity obtained by selling new common stocks of a company. It is basically, the cost of retained earnings income adjusted for floating costs. Floating costs are incurred when the company issues new securities for the first time.

Answer 20

c)

Expert Solution

Summary Introduction

To discuss: Target capital structure.

Explanation of Solution

The target capital structure is nothing but the relative amount of debt, common equity and preferred stock that an organization desires. Calculation of weighted average cost of capital is totally based on these target weights.

Answer 21

c)

Expert Solution

Answer 22

c)

Expert Solution

Answer 23

Expert Solution

Answer 24

Summary Introduction

To discuss: Target capital structure.

Answer 25

Explanation of Solution

The target capital structure is nothing but the relative amount of debt, common equity and preferred stock that an organization desires. Calculation of weighted average cost of capital is totally based on these target weights.

Answer 26

d)

Expert Solution

Summary Introduction

To discuss: Flotation cost and cost of new external common equity.

Explanation of Solution

The concept of floatation cost is considered when a company issues a new security. This includes fees paid to investment bankers and other legal fees. The cost of new common equity is better than that of not unusual equity raised internally by reinvesting earnings. The projects financed with external equity must earn higher returns, since the projects must cover these flotation costs.

Answer 27

d)

Expert Solution

Answer 28

d)

Expert Solution

Answer 29

Expert Solution

Answer 30

Summary Introduction

To discuss: Flotation cost and cost of new external common equity.

Answer 31

Explanation of Solution

The concept of floatation cost is considered when a company issues a new security. This includes fees paid to investment bankers and other legal fees. The cost of new common equity is better than that of not unusual equity raised internally by reinvesting earnings. The projects financed with external equity must earn higher returns, since the projects must cover these flotation costs.

Answer 32

Ch. 11 - Define each of the following terms: Weighted...Ch. 11 - Prob. 2Q Ch. 11 - Prob. 3Q Ch. 11 - Distinguish between beta (i.e., market) risk,...Ch. 11 - Suppose a firm estimates its overall cost of...Ch. 11 - 11-1 After-Tax Cost of Debt Calculate the...Ch. 11 - Cost of Preferred Stock Duggins Veterinary...Ch. 11 - Prob. 4P Ch. 11 - Prob. 5P Ch. 11 - Prob. 6P

Concept explainers

Videos

Explanation of Solution

Explanation of Solution

Explanation of Solution

Explanation of Solution

Want to see more full solutions like this?

Chapter 11 Solutions