question archive a) The cost of debt is 2%
a) The cost of debt is 2%
Subject:FinancePrice:2.86 Bought15
a) The cost of debt is 2%. The firm's tax rate is 25 %. b) The current price for preferred shares in the market is $150 and the perpetual annual dividend is $40. c) Harry Morris's common shares are currently selling at $40 per share, its last dividend (DO) was $6, and dividends are expected to grow at a constant rate of 3 % in the foreseeable future. d) Harry Morris's capital structure is 50 % long-term debt, 25 % preferred stock and 25 % common stock. Requirements 1. Why does cost of capital play an important role in decision-making? (10 points) 2. Mention the two ways that companies can raise common equity? (20 points) 3. Determine the cost of Preferred Stock - rp. (15 point) 4. Determine the cost of Common Stock - rs. (20 point) 5. Calculate the WACC. (25 point) 6. When it comes to the return on invested capital and cost of capital, when should a company accept or reject a project? (10 points)
Purchase A New Answer
Custom new solution created by our subject matter experts
GET A QUOTE
Answer Preview
1. Role of cost of capital in financial decision making :
a.Cost of capital helps in taking Capital budgeting decision. If cost of a investment project is higher that cost of capital than that project should be rejected .
b.Comparing the various costs of different sources of capital, the financial manager can select the most economical source of finance and can designed a balanced capital structure.
c.Helpful in taking dcisions regarding dividend policy.
2. Companies can raise common equity by IPO(intial public offering), angel investors or by ventrue capital.
3. cost of prefer stock = dividend/ Market price
=40/150 =0.266
4. Cost of equity share=(D1/P) +g
=6/40 + .03
=0.15+0.03 =0.18
5. Cost of Debt = 0.02(1-0.25) =0.02*0.75 = 1.5%
WACC = Wd*Cd +Wp*Cp+We*Ce
=0.5*0.015 +0.25*0.266 +0.25*0.18
=0.0075+0.0665+0.045 = 0.119 =11.9%
6. A project should accpted when return on invested capital is more than cost of capital.
