Table 9.2 A Firm Has Determined Its Optimal Structure Which Is Composed

question 103

Multiple Choice

Table 9.2
A firm has determined its optimal structure which is composed of the following sources and target market value proportions. Debt: The firm can sell a 15-year, $1,000 par value, 8 percent bond for $1,050. A flotation cost of 2 percent of the face value would be required in addition to the premium of $50.
Common Stock: A firm's common stock is currently selling for $75 per share. The dividend expected to be paid at the end of the coming year is $5. Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was $3.10. It is expected that to sell, a new common stock issue must be underpriced $2 per share and the firm must pay $1 per share in flotation costs. Additionally, the firm has a marginal tax rate of 40 percent.
-The firm's after-tax cost of debt is ________. (See Table 9.2)

• A) 4.6 percent
• B) 6 percent
• C) 7 percent
• D) 7.7 percent

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Definitions:

Maximizing Losses

Contrary to economic rationality, refers to theoretical actions or strategies that would lead to the greatest possible financial losses.

Diminishing Returns

A principle stating that as more investment is made in a particular resource, the marginal gain in output will eventually decrease.

Fixed Factor

Inputs in production that cannot be easily increased or decreased in the short term, such as buildings and land.

Marginal Cost

The cost associated with producing an additional unit of output, significant in decision-making processes related to production levels.