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Financial Institutions, Investments, and Management

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3. Sun Instruments expects to issue new stock at $34 a share with estimated flotation costs of 7 percent of the market price. The company currently pays a $2.10 cash dividend and has a 6 percent growth rate. What are the costs of retained earnings and new common stock?
4. A firm's current balance sheet is as follows:
Assets $100 Debt $10
Equity $90
. What is the firm's weighted-average cost of capital at various combinations of debt and equity, given the following information?
Debt/Assets After-Tax Cost of Debt Cost of Equity Cost of Capital
0% 8% 12% ?
10 8 12 ?
20 8 12 ?
30 8 13 ?
40 9 14 ?
50 10 15 ?
60 12 16 ?
a. Construct a pro forma balance sheet that indicates the firm's optimal capital structure. Compare this balance sheet with the firm's current balance sheet. What course of action should the firm take?
Assets $100 Debt $?
Equity $?
b. As a firm initially substitutes debt for equity financing, what happens to the cost of capital, and why?
c. If a firm uses too much debt financing, why does the cost of capital rise?

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Solution Summary

Financial institutions are examined. The investment and management strategies are determined.

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Question3:
Sun Instruments expects to issue new stock at $34 a share with estimated flotation costs of 7 percent of the market price. The company currently pays a $2.10 cash dividend and has a 6 percent growth rate. What are the costs of retained earnings and new common stock? A firm's current balance sheet is as follows:
Cost of retained earnings =D0*(1+g)/P0+g
12.55%

Cost of new equity = Cost of retained ...

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