We at F&H have of course noted the complaints of a few spineless investors and uninformed security analysts about the slow growth of profits and dividends. Unlike those confirmed doubters, we have confidence in the long-run demand for mechanical encabulators, despite competing digital products. We are therefore determined to invest to maintain our share of the overall encabulalor market. F&H has a rigorous CAPFX approval process, and we are confident of returns around 8% on investment. That’s a far better return than F&H earns on its cash holdings. The CFO went on to explain that F&H invested excess cash in short-term U.S. government securities, which are almost entirely risk-free but offered only a 4%
- a. Is a
forecasted 8% return in the encabulator business necessarily better than a 4% safe return on short-term U.S. government securities? Why or why not? - b. Is F&H’s opportunity cost of capital 4%? How in principle should the CFO determine the cost of capital?
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Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
- The Cost of Capital: Cost of New Common Stock If a firm plans to issue new stock, flotation costs (investment bankers' fees) should not be ignored. There are two approaches to use to account for flotation costs. The first approach is to add the sum of flotation costs for the debt, preferred, and common stock and add them to the initial investment cost. Because the investment cost is increased, the project's expected return is reduced so it may not meet the firm's hurdle rate for acceptance of the project. The second approach involves adjusting the cost of common equity as follows:The difference between the flotation-adjusted cost of equity and the cost of equity calculated without the flotation adjustment represents the flotation cost adjustment. Quantitative Problem: Barton Industries expects next year's annual dividend, D1, to be $1.80 and it expects dividends to grow at a constant rate g = 4.2%. The firm's current common stock price, P0, is $20.60. If it needs to issue new common…arrow_forwardAutomotive industry has been generally considered to be at the maturity stage of the industry life cycle. Which of the following observations is consistent with this argument? Many firms pay zero dividends to shareholders Industry growth rate is similar to the growth rate of the overall economy Product lineup continues expanding with innovations High profit margins attract new entrants Which of the followings is correct about the capital market line (CML)? Group of answer choices It can be tangent to the investment opportunity set of all risky assets Its Y-intercept is the Sharpe ratio for the market portfolio It is going through the minimum-variance portfolio Its slope is the expected return on the market portfolio An investor is analyzing two stocks: S1 and S2. The P/E ratio of S1 is 30, and the P/E ratio of S2 is 170. The investor concludes that S2 is relatively overvalued due to its substantially higher P/E ratio. Which of the following information can…arrow_forward– Capital Structure Decisions. Firms with relatively high nonfinancial fixed costs are said to have a high degree of what? Why is the following statement true? “Other things being the same, firms with relatively stable sales are able to carry relatively high debt ratios.” MACC Inc. has fixed operating costs of $500,000 and variable costs of $50per unit. If it sells the product for $75 per unit, what is the break-even quantity? show work in excel.arrow_forward
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