Question

5. Cost of new common stock Flotation costs represent the fees that firms pay to investment bankers to help them issue new common stock. True or False: The following statement accurately describes how firms make decisions related to issuing 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 $600,000; however, in raising this capital, Green Caterpillar will incur an additional flotation cost of 2%. At the end of the year, the project is expected to produce a cash inflow of $720,000. 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 $22.35 and is expected to pay a dividend of $1.36 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 2% 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 50% debt, 5% preferred stock, (rounded to the nearest whole and 45% common stock. Green Caterpillar Garden Supplies Inc.'s retained earnings breakpoint is dollar).

Answer 1

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| 0 = a = 3 3 4 5 W ? v L 1 01:58 ENG 05-02-20208 FV282 X fix FOFPFO FR FS FT FUFV F W Formula Barx 282 283 FILL IN THE BLANK : FLOTATION COSTS 284 285 286 1 FALSE: 287 FLOTATION COSTS NEED TO BE TAKEN INTO ACCOUNT WHEN CALCULATING THE COST OF ISSUING NEW STOCK, BUT THEY DO NOT NEED TO BE TAKEN INTO ACCOUNT WHEN RAISING CAPITAL FROM RETAINED EARNINGS 288 289 290 291 2 INITIAL INVESTMENT ADD : FLOTATION COST (2%) TOTAL COST CASH INFLOW RATE OF RETURN = (720000/612000) - 1 = 600000 12000 612000 720000 17.65% 292 293 294 295 296 3 PO = 22.35 D1=1.36 g= 4% f=2% 298 299 ke = 01/PO(1-f) + g = 1.36/(22.35(1-0.02)) + 0.04 = 10.21% 300 301 4 COMPANY'S RETAINED EARNINGS BREAK POINT = ADDITION TO RETAINED EARNINGS/ WEIGHT OF EQUITY 745000/0.45 = 1655556 302 303 304 305 306 KE CAPM UTILITY, SHARPE, beta coNvexity DGM beta port future INDEX INTL CAP BUD SANDRINE LEASING PV, FV, ANNUITY DIR right clean YIEL ... ►