Allison Engines Corporation Has Established a Target Capital Structure of 40

question 4

Multiple Choice

Allison Engines Corporation has established a target capital structure of 40 percent debt and 60 percent common equity.The firm expects to earn $600 in after-tax income during the coming year,and it will retain 40 percent of those earnings.The current market price of the firm's stock is P0 = $28; its last dividend was D0 = $2.20,and its expected dividend growth rate is 6 percent.Allison can issue new common stock at a 15 percent flotation cost.What will Allison's marginal cost of equity capital (not the WACC) be if it must fund a capital budget requiring $600 in total new capital?

• A) 15.8%
• B) 13.9%
• C) 7.9%
• D) 14.3%
• E) 9.7%

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Definitions:

Terms 4/15, N/60

A commercial credit term indicating that a 4% discount is available if paid within 15 days, with the net (full) amount due within 60 days.

Discount Lost

The expense incurred when a company fails to take advantage of the early payment discounts offered by suppliers.

Gross Method

An accounting method for recording purchases at the invoice's gross amount before any trade discounts are subtracted.

Net Method

A way to record purchases of inventory with a discount for early payment, where the purchase is recorded at the net of the discount and the discount is lost if not taken.