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3.) In computing the cost of capital, do we use the historical costs of existing debt and equity or the current costs as determined in the market? Why?

4.) Why is the cost of debt less than the cost of preferred stock if both securities are priced to yield 10 percent in the market?

8.) Why is the cost of issuing new common stock (Kn) higher than the cost of retained earnings (Ke)?

9.) Why might a stock dividend or a stock split be of limited value to an investor?

11.) What advantages to the corporation and the stockholder do dividend reinvestment plans offer?

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Solution Summary

This solution addresses computing the cost of capital, cost of debt, cost of new common stock, splitting of a stock and advantages for dividend reinvestment plans.

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3) In computing the cost of capital, do we use the historical costs of existing debt and equity or the current costs as determined in the market? Why?

We use the current costs for the various sources of financing as we are interested to know the cost of capital (funds) to finance the future projects rather than past projects.

4) Why is the cost of debt less than the cost of preferred stock if both securities are priced to yield 10 percent in the market?

Cost of debt is lower as the interest on debt is a tax-deductible expense. For example, the post tax cost of a 10 percent rate of interest ...

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