## 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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