Chapter 11 Cost of Capital Po $30 F = Flotation cost, new common stock $1.50 g =
ID: 2710196 • Letter: C
Question
Chapter 11 Cost of Capital Po $30 F = Flotation cost, new common stock $1.50 g = 9% K$1.20 $1.20 $28.50 K., $30 $1.50 + 9% + 9%-4.21% + 9% = 13.21% PROBLEMS connect selected problems are available with Connect. Pleasese the preface for more information. Selected problems are available with Connect. Please see the preface for more information. FINANCE Basic Problems L. In March 2010, Hertz Pain Relievers bought a massage machine that provided a c return of 8 percent. It was financed by debt costing 7 percent. In August 2010,I Mr. Hertz came up with a heating compound that would have a return of 14 percent. The Chief Financial Officer, Mr. Smith, told him it was impractical because it would require the issuance of common stock at a cost of 16 percent to finance the purchase. Is the company following a logical approach to using its cost of capital? 2 Sneedy Delivery Sustems can buy a niece of eauipment that is anticipated to pro-Explanation / Answer
Per my opinion the company is following a logical view of not accepting to invest for a return of 14% when its cost of equity is higher then the return.
The theory says :
A company's cost of equity (COE) is a measure of the returns that the stock market demands for investors who will bear the risks of ownership. Cost of equity is a part of a company's capital structure. (along with preferred stock, common stock, and cost of debt).
A high cost of equity indicates that the market views the company's future as risky, thus requiring greater return rates to attract investments. A lower cost of equity indicates just the opposite. Not surprisingly, cost of equity is a central concern to potential investors applying the capital asset pricing model (CAPM), who are attempting to balance expected rewards against the risks of buying and holding the company's stock.
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