Finance Flashcards

Finance Chapter 11

A firm is paying an annual dividend of $2.65 for its PREFERRED STOCK that is selling for $37. Selling (flotation) cost of $3.30. What’s the after-tax cost of the preferred stock? 2.65/57-3.30= $4.93
A firm in a stable industry should use: A LARGE amount of debt to lower the cost of capital
A firm’s debt-to-equity ratio varies at times because a firm will want to: -Take advantage of timing its fund-raising in order to minimize costs over the long run-Sell common stock when prices are high and bonds when interest rates are low-The market allows some leeway in the debt-to-equity ratio before penalizing the firm with a higher cost of capital.
For a profitable firm paying 5% for new debt, the higher the firm’s tax rate, The LOWER the after-tax cost of debt.
The after-tax cost of preferred stock to the issuing corporation is the SAME as the before-tax cost
A firm’s cost of financing, in an overall sense, is equal to its -WACC-Required yield-Required rate of return
Flotation cost is the: COST of issuing NEW stock
The overall WACC is used instead of costs for individual sources because The use of the cost for specific sources of capital would make investment decisions inconsistent
If flotation cost goes up, the cost of retained earnings will stay the same.
The after-tax cost of debt will typically be below WACCCost of equityBefore-tax cost of debt
Although debt financing is usually the cheapest component of capital, it cannot be used in excess because the financial risk of the firm may increase and drive up the cost of financing
The cost of equity capital in the form of new common stock will be higher than the cost of retained earnings because of the existence of flotation costs

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