Purchase Solution

# Cost of capital

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A) David Ortiz Motors has a target capital structure of 40\$ debt and 60% equity. The yield to maturity on the company's outstanding bonds is 9%, and the company's tax rate is 40%. Ortiz's CFO has calculated the company's WACC as 9.96%. What is the company's cost of equity capital?

B) On January 1, the total market value of Tysseland Company was \$60 million. During the year, the company plans to raise and invest \$30 million in new projects. The firm's [resent market value capital structure, shown below, is considered to be optimal. Assume there is no short term debt.

Debt \$30,000,000
Common Equity 30,000
Total capital \$60,000,000

New bonds will have 8% coupon rate, and they will be sold at par. Common stock is currently selling at \$30 a share. Stockholders' required rate of return is estimated to be 12%, consisting f a dividend yield of 4% and an estimated constant growth rate of 8%. (The next expected dividend is \$1.20, so \$1.20/\$30 = 4%) The marginal corporate tax rate is 40%.

To maintain the present capital structure, how much of the new investment must be financed by common equity?

Assume that there is sufficient cash flow such that Tysseland can maintain its target capital structure without issuing additional shares of equity. What is the WACC?

Suppose now that there is not enough internal cash flow and the firm must issue new shares of stock. Qualitatively speaking, what will happen to the WACC?

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A) David Ortiz Motors has a target capital structure of 40\$ debt and 60% equity. The yield to maturity on the company's outstanding bonds is 9%, and the company's tax rate is 40%. Ortiz's CFO has calculated the company's WACC as 9.96%. What is the company's cost of equity capital?

B) On January 1, the total market value of Tysseland Company ...

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