Here is the condensed balance sheet for Skye Computer Company (in thousands of dollars:

Current Assets $2000
Net Fixed Assets $3,000
Total Assets $5,000

Current Liabilities $900
Long-Term Debt $1,200
Preferred Stock $250
Common Stock $1,300
Retained Earnings $1,350
Total Common Equity $2,650
Total Liabilities and Equity $5,000

Skye Computer's earnings per share last year were $3.20; the stock sells for $55, and last year's dividend was $2.10. A flotation cost of 10 percent would be required to issue new common stock. Skye's preferred stock pays a dividend of $3.30 per share, and new preferred stock could be sold at a price to net the company $30 per share. Security analysts are projecting that the common dividend will grow at a rate of 9 percent per year. The firm can issue additional long-term debt at an interest rate (before-tax cost) of 10%, and its marginal tax rate is 35%. The market risk premium is 5%, the risk-free rate is 6%, and Skye's beta is 1.516. In its cost of capital calculations, the company considers only long-term capital; hence it disregards current liabilities for that purpose.

a. Calculate the cost of each capital component, that is, the after-tax cost of debt, the cost of preferred stock, the cost of equity from retained earnings, and the cost of newly issued common stock. Use the DCF method to find the cost of common equity.

b. Now calculate the cost of common equity from retained earnings using the CAPM method.

c. What is the cost of new common stock, based on CAPM? (Hint: Find the difference between Ke and Ks as determined by the DCF method, and add that differential to the CAPM value for Ks.)

d. If Skye Computer continues to use the same capital structure, what is the firm's WACC assuming (1) that it uses only retained earnings for equity and (2) that it expands so rapidly that it must issue new common stock?

Solution Summary

Calculates cost of different components of capital-after-tax cost of debt, the cost of preferred stock, the cost of equity from retained earnings, and the cost of newly issued common stock. Cost of equity is calculated using the DCF method and CAPM.

In a world that is not perfect but risk neutral assume that the firm has projects worth $100 in down state and $500 in the up-state. The cost of capital for projects is 25%. However, if you could finance it with 50-50 debt, the cash flow rights alone are enough to make the cost of capital lower than 20%. Managers are intransigen

A. Generally, which of the following is true? (where rE is the cost of equity, rD is the cost of debt and rA s the cost of capital for the firm.
A. rD> rA> rE
B. rE> rD> rA
C. rE> rA> rD
D. None of the above is true
B. If a firm is unlevered and has a cost of equity capital 9%, what would the cost of equity be

one question need help with 15.12 all work to be shown to increase comprehension and balance against my solution. What is the firms optimal capital structure and weighted average cost of capital.

Please assist in responding to the following questions regarding debt financing:
As a firm initially substitutes debt for equity financing, what happens to the cost of capital, and why?
If a firm uses too much debt financing, why does the cost of capital rise?

Question: The weighted average cost of capital for firm X is currently 10%. Firm X is considering a new project, but must raise new debt to finance the project. Debt represents 25% of the capital structure. If the after tax cost of debt will rise form 7% to 8%, what is the marginal cost of capital?
A)10.25%,
B)10.75%
C

Please tell me how to find K given the parameters in the problem for #9.50. You can see how I'm trying to do it, but I can't figure out what to plug in for Cd and Ce from what's given.

Please help answer the following question. Provide at least 200 words in the solution. Provide step by step calculations in the answer.
1. Why would the cost of capital be considered an opportunity cost?
2. Why is the cost of capital measured on an after-tax basis? Would this affect any specific cost components?

Discuss the concept of valuation with leverage. How could we estimate the appropriate cost of capital for a project? Explore how the financing decision of the firm can affect both the cost of capital and the set of cash flows that we discount?