28) Meacham Corp.

wants to issue bonds with a 9% coupon rate, a face value of $1,000, and 12 years to
maturity. Meacham estimates that the bonds will sell for $1,090 and that flotation costs will equal $15 per
bond. Meacham Corp. common stock currently sells for $30 per share. Meacham can sell additional
shares by incurring flotation costs of $3 per share. Meacham paid a dividend yesterday of $4.00 per share
and expects the dividend to grow at a constant rate of 5% per year. Meacham also expects to have $12
million of retained earnings available for use in capital budgeting projects during the coming year.
Meacham's capital structure is 40% debt and 60% common equity. Meacham's marginal tax rate is 35%.
a. Calculate the after-tax cost of debt assuming Meacham's bonds are its only debt.
b. Calculate the cost of retained earnings.
c. Calculate the cost of new common stock.
d. Calculate the weighted average cost of capital assuming Meacham's total capital budget is $30
million.
Answer:
a. YTM with Net Proceeds = $1,075 is 8.0%. After-tax cost of debt = 8.0%(1 - .35) = 5.2%
b. (($4.00(1.05))/$30) + 5% = 19%
c. (($4.00(1.05))/($30 - $3)) + 5% = 20.56%
d. At $30 million, debt = $12 million and common equity = $18 million. Available retained earnings are
$12 million, so new common stock will equal $6 million.
WACC = (.4)(5.2%) + (.4)(19%) + (.2)(20.56%) = 13.79%
Diff: 3 Page Ref: 310
Keywords: Weighted Average Cost of Capital, Cost of Debt, Cost of Retained Earnings, Cost of New
Common Stock, Capital Structure

29) Office Clean Corporation has a capital structure consisting of 30 percent debt and 70 percent common
equity. Assuming the capital structure is optimal, what amount of total investment can be financed by a
$35 million addition to retained earnings without selling new common stock?
Answer: Capital budget = $35 million/.7 = $50 million
Diff: 2 Page Ref: 310
Keywords: Optimal Capital Structure, Total Capital Budget

30) Last year Gator Getters, Inc. had $50 million in total assets. Management desires to increase its plant
and equipment during the coming year by $12 million. The company plans to finance 40 percent of the
expansion with debt and the remaining 60 percent with equity capital. Bond financing will be at a 9
percent rate and will be sold at its par value. Common stock is currently selling for $50 per share, and
flotation costs for new common stock will amount to $5 per share. The expected dividend next year for
Gator is $2.50. Furthermore, dividends are expected to grow at a 6 percent rate far into the future. The
marginal corporate tax rate is 34 percent. Internal funding available from additions to retained earnings is
$4,000,000.
a. What amount of new common stock must be sold if the existing capital structure is to be maintained?
b. Calculate the weighted marginal cost of capital at an investment level of $12 million.
Answer:
a.
Equity needed = $12 million × 0.6 = $7.2 million
Less additions to R/E 4.0 million
New common stock $3.2 million

b.
Kd = 9(1 - .34) = 5.94%
Knc = $2.50/$45 + 0.06 = 11.56%
MCC = 0.4 × 5.94% + 0.6 × 11.56% = 9.31%
Diff: 2 Page Ref: 307
Keywords: After-tax Cost of Debt, Cost of New Common Stock, Marginal Cost of Capital
Learning Objective 9.4

5) A corporate bond has a face value of $1,000 and a coupon rate of 5%. The bond matures in 15 years
and has a current market price of $925. If the corporation sells more bonds, it will incur flotation costs of
$25 per bond. If the corporate tax rate is 35%, what is the after-tax cost of debt capital?
A) 3.74%
B) 4.45%
C) 5.29%
D) 6.78%
Answer: A
Diff: 2 Page Ref: 316
Keywords: After-tax Cost of Debt, Flotation Costs, Bond Valuation

6) A corporate bond has a face value of $1,000 and a coupon rate of 9%. The bond matures in 14 years
and has a current market price of $946. If the corporation sells more bonds, it will incur flotation costs of
$26 per bond. If the corporate tax rate is 35%, what is the after-tax cost of debt capital?
A) 5.57%
B) 6.56%
C) 8.18%
D) 7.31%
Answer: B
Diff: 2 Page Ref: 316
Keywords: After-tax Cost of Debt, Flotation Costs, Bond Valuation

7) TC, Inc. has $15 million of outstanding bonds with a coupon rate of 10 percent. The yield to maturity
on these bonds is 12.5 percent. If the firm's tax rate is 30 percent, what is relevant cost of debt financing
to TC, Inc.?
A) 13.75 percent
B) 8.75 percent
C) 7.00 percent
D) 3.75 percent
Answer: B

8) XRT, Inc. is issuing a $1,000 par value bond that pays 8.5% interest annually. Investors are expected to
pay $1,100 for the 12-year bond. The firm will pay $50 per bond in flotation costs. What is the after-tax
cost of new debt if the firm is in the 35% tax bracket?
A) 8.23%
B) 4.55%
C) 4.70%
D) 7.45%
Answer: C
Diff: 2 Page Ref: 316
Keywords: After-tax Cost of Debt, Flotation Costs
9) All the following variables are used in computing the cost of debt EXCEPT
A) maturity value of the debt.
B) market price of the debt.
C) number of years to maturity.
D) risk-free rate.
Answer: D
Diff: 2 Page Ref: 316
Keywords: After-tax Cost of Debt

10) Blammo, Inc. has a target capital structure of 30% debt and 70% equity. The firm is planning to
invest in a project that will necessitate raising new capital. New debt will be issued at a before-tax yield
of 14%, with a coupon rate of 10%. The equity will be provided by internally generated funds so no new
outside equity will be issued. If the required rate of return on the firm's stock is 22% and its marginal tax
rate is 35%, compute the firm's cost of capital.
A) 18.00%
B) 18.13%
C) 19.68%
D) 15.55%
Answer: B
Diff: 2 Page Ref: 316
Keywords: Weighted Average Cost of Capital, After-tax Cost of Debt

11) Donner, Inc. will finance a proposed investment by issuing new securities while maintaining its
optimal capital structure of 60% debt and 40% equity. The firm can issue bonds at a price of $950.00
before $15 flotation costs. The 10-year bonds will have an annual coupon rate of 8% and a face value of
$1,000. The company can issue new equity at a before-tax cost of 16% and its marginal tax rate is 34%.
What is the appropriate cost of capital to use in analyzing this project?
A) 3.63%
B) 8.77%
C) 9.97%
D) 11.81%
Answer: C
Diff: 2 Page Ref: 312
Keywords: After-tax Cost of Debt, Cost of New Common Stock, Weighted Average Cost of Capital

12) QRM, Inc.'s marginal tax rate is 35%. It can issue 10-year bonds with an annual coupon rate of 7%
and a par value of $1,000. After $12 per bond flotation costs, new bonds will net the company $966 in
proceeds. Determine the appropriate after-tax cost of new debt for the firm to use in a capital budgeting
analysis.
A) 2.62%
B) 4.87%
C) 7.50%
D) 7.8%
Answer: B
Diff: 2 Page Ref: 312
Keywords: After-tax Cost of Debt, Flotation Costs