# Company's Cost of Capital Essay

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Chp. 9 Mini Case &nbsp;&nbsp;&nbsp;&nbsp;&nbsp; During the last few years, Harry Davis Industries has been too constrained by the high cost of capital to make many capital investments. Recently, though, capital costs have been declining, and the company has decided to look seriously at a major expansion program that had been proposed by the marketing department. Assume that you are an assistant to Leigh Jones, the financial vice president. Your first task is to estimate Harry Davis’s cost of capital. Jones has provided you with the following data, which she believes may be relevant to your task. 1.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The firm’s tax rate is 40% 2.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The current price of Harry Davis’s 12% coupon,…show more content…
What is the firm’s cost of preferred stock? Kps = Dpn = 0.1 (\$100) = \$10 = 0.090 = 9% &nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; \$133.10 - \$2 \$111.10 2. Harry Davis’s preferred stock is riskier to investors than its debt, yet the preferred’s yield to investors is lower than the yield to maturity on the debt. Does this suggest that you have made a mistake? (Taxes) Preferred dividends are nontaxable and this causes it to have a lower before tax yield than debt. d.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;1. What are the two primary ways companies raise common equity? 1. Retaining earnings 2. Issuing new common stock 2. Why is there a cost associated with reinvested earnings? &nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Opportunity cost, reinvesting the earnings means they won’t actually be able to use the money for what they want. 3. Harry Davis doesn’t plan to issue new shares of common stock. Using the CAPM approach, what is Harry Davis’s estimated cost of equity? &nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;.07 + (.06) 1.2 = 14.2% e.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;1. What is the estimated cost of equity using the discounted cash flow (DCF) approach? 4.19 (1.05) + .50 = 13.8% \$50 2. Suppose the firm has historically earned 15% on equity (ROE) and retained 35% of earnings, and investors expect this situation to continue in the