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Case and additional information is attached.

Case 19: Determining the Cost of Capital

The Oceanic Corporation, a Chesapeake, VA based company, was established in 1994. Glenn Rodgers III founded the corporation, which was privately owned at the time, after his retirement from Norentech Corporation.

Table 1
The Oceanic Corporation
Balance Sheet

Cash 5000
Accounts Receivables 10000
Inventory 20000
Total Current Assets 35000
Land & Buildings (net) 43000
Plant and Equipment (net) 45000
Total Fixed Assets 88000
Total Assets 123000

Accounts Payable 8000
Accruals 5000
Notes Payable 10000
Total Current Liabilities 23000
Long-term debt 40000
Retained Earnings 10000
Common stock
(5 million shares outstanding) 50000
Total liabilities and shareholders' equity 123000

Table 2
The Oceanic Corporation
Sales, Earnings, and Dividend History

Year Sales EPS Dividends/Share
1998 $24,000,000 $0.48 $0.10
1999 28,800,000 0.58 0.12
2000 36,000,000 0.72 0.15
2001 45,000,000 0.86 0.18
2002 51,750,000 0.96 0.20
2003 62,100,000 1.06 0.22
2004 74,520,000 1.20 0.25


1. Why do you think Larry Stone wants to estimate the firm's hurdle rate? Is it justifiable to use the firm's weighted average cost of capital as the divisional cost of capital? Please explain.

2. How should Stephanie go about figuring out the cost of debt? Calculate the firm's cost of debt.

3. Comment on Stephanie's assumptions as stated in the case. How realistic are they?

4. Why is there a cost associated with a firm's retained earnings?

5. How can Stephanie estimate the firm's cost of retained earnings? Should it be adjusted for taxes? Please explain.

6. Calculate the firm's average cost of retained earnings.

7. Can flotation costs be ignored in the analysis? Explain.

8. How should Stephanie calculate the firm's hurdle rate? Calculate it and explain the various steps.

9. Can Larry assume that the hurdle rate calculated by Stephanie would remain constant? Please explain.

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