Question

common stock A firm will never have to take flotation costs into account when calculating the cost of raising capital from True or False: The following statement accurately describes how firms make decisions related to issung new common stock The cost of issuing new common stock is calculated the same way as the cost of raising equity capital from retained earnings. False: Flotation costs need to be taken into account when calculating the cost of issuing new common stock, but they do not need to be taken into account when raising capital from retained earnings True: The cost of retained earnings and the cost of new common stock are calculated in the same manner, except that the cost of retained earnings is based on the firm's existing common equity, while the cost of new common stock is based on the value of the firm's share price net of its flotation cost. Green Caterpillar Garden Supplies Inc. is considering a one year project that requires an initial investment of $400,000; however, in rang this capital, Green Caterpillar will incur an additional flotation cost of 6%. At the end of the year, the project is expected to produce a cash inflow of $480,000. The rate of return that Green Caterpillar expects to earn on the project after its flotation costs are taken into account is Green Caterpillar has a current stock price of $33.35 and is expected to pay a dividend of $2.45 at the end of next year. The company's growth rate is expected to remain constant at 4%. If the issue's flotation costs are expected to equal 6% of the funds raised the flotation-cost-adjusted cost of the firm's new common stock is Green Caterpillar's addition to earnings for this year is expected to be $745,000. Its target capital structure consists of te debt. 5 preferred stock and 60% common stock. Green Caterpillar Garden Supplies Inc.'s retained earnings breakpoint is _ (rounded to the nearest whole dollar).

Answer 1

rate positively ..

Answer a)	Answer is option : Issuing new common stock
Answer b)	Statement is False: Flotation cost need to be taken into account when calculating the cost of issuing new common stock, but they not need to be taken into account when raising capital from retained earning.
Answer c)
	intial investment			400000
	Flotation cost			6%
	Therefore firm must need to raise 400000/(1-6%) to get net of 400000 as investable amount
i	Total cost of investment =				425,532
ii	expected cash inflow =				480,000
iii=ii-i	return					54,468
iv=iii/i	rate of return					12.80%
Answer d)	Current share price =			33.35
	Expected dividend =			2.45
	growth rate =				4.00%
	flotation cost =				6.00%
	We can use DDM model to find the cost of common equity
	Formula used =
	cost of equity =		Expected dividend/ (Price *(1-flotation cost)) + growth rate
			=(2.45/(33.35*(1-6%))+4%)
			11.82%
Answer e)
	retained earning breakpoint is the point where firm need not to go with issuing if new stock .
	Given that current equity ratio = 60%
	Additional earning =		745000
	At current capital structure firm need not to go for issue of new stock upto the investment of = 745000/60%
	earning breakpoint			1241667
	hence, correct answer is option :	1241667