Answers
rate positively ..
| Answer a) | statement is TRUE : Firm will raise all equity they can from retained earning before issuing new common stock, because capital from retained earning is cheaper than capital from issuing new common stock | ||||||||||
| Answer b) | |||||||||||
| intial investment | 450000 | ||||||||||
| Flotation cost | 2% | ||||||||||
| Therefore firm must need to raise 450000/(1-2%) to get net of 475000 as investable amount | |||||||||||
| i | Total cost of investment = | =450000/98% | 459183.7 | ||||||||
| ii | expected cash inflow = | 595000 | |||||||||
| iii=ii-i | return | 135816.33 | |||||||||
| iv=iii/i | rate of return | 29.58% | |||||||||
| Answer c) | Current share price = | 33.35 | |||||||||
| Expected dividend = | 2.03 | ||||||||||
| growth rate = | 8.70% | ||||||||||
| flotation cost = | 6.50% | ||||||||||
| We can use DDM model to find the cost of common equity | |||||||||||
| Formula used = | |||||||||||
| cost of equity = | Expected dividend/ (Price *(1-flotation cost)) + growth rate | ||||||||||
| =(2.03/(33.35*(1-6.5%))+8.7%) | |||||||||||
| 15.21% | |||||||||||
| Answer d) | |||||||||||
| retained earning breakpoint is the point where firm need not to go with issuing if new stock . | |||||||||||
| Given that current equity ratio = 60% | |||||||||||
| Additional earning = | 745000 | ||||||||||
| At current capital structure firm need not to go for issue of new stock upto the investment of = 745000/60% | |||||||||||
| earning breakpoint | 1241667 | ||||||||||
| hence, correct answer is option : | 1241667 | ||||||||||
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