Assignment Chapter 9
Answer all questions in full sentences:
Questions:
- What are the net proceeds from the sale of a bond?
Sol:
Net Bond Proceeds means the net proceeds obtained from the issuance, selling and distribution of the Bonds, reflecting the overall purchase price of the Bonds, including any premiums charged as part of the purchase price of the Bonds, but excluding the accumulated interest, if any, on the Bonds charged by the original purchaser of the Bonds;
Net proceeds are the amount a business earns from a bond or stock sale. Net proceeds are determined by subtracting floatation costs from the sale value of the security or bond. (NP=Sale value-Float cost).
- What are flotation costs, and how do they affect a bond’s net proceeds?
Sol:
Flotation costs are the expense of issuing and selling a preferred and common stock-bond or securities. This included the payment of underwriting and operating expenses. Once businesses sell new common stock, they employ investment bankers. This fee to bankers is an expense to the flotation. Flotation costs minimize the net profits of bonds as these expenses are taken out of the bond funds available.
- What methods can be used to find the before-tax cost of debt?
Sol:
These are the methods:
1.)Quotation process- The YTM will be the same as the reported coupon rate if the market price is equal to the par value of the bond. Look at YTM about current bonds
2.) Method of Calculator- Same as IRR find. Apply calc.
3.) Method of approximation-Using calculation to find the debt expense before tax (rd)
- How is the before-tax cost of debt converted into the after-tax cost?
Sol:
Rd is translated into Ri by taking into account the tax benefits arising from debt attributable to interest payments that are tax-deductible for businesses. ri=rd(1-T)
- How do the constant-growth valuation model and capital asset pricing model methods for finding the cost of common stock differ?
Sol:
CAPM takes the non-diversifiable risk(B) of businesses into account. No expense considered for the floatation. The model of Constant Growth does not recognize risk; it makes use of market price. Consideration is given to the flotation costs.
- Why is the cost of financing a project with retained earnings less than the cost of funding it with a new issue of common stock?
Sol:
Since retained earnings do not account for losses on flotation.
- What is the weighted average cost of capital (WACC), and how is it calculated?
Sol:
WACC is the anticipated, long-term average potential capital cost. It is calculated by measuring the expense of each particular type of capital by its proportion in the capital structure of the companies.
- What is cost of capital?
Sol:
The cost of capital reflects the value of an investment to companies. It is the minimum rate of return business will receive to maximize the valuation of the companies.
- What role does the cost of capital play in the firm’s long-term investment decisions? How does it relate to the firm’s ability to maximize shareholder wealth?
Sol:
The cost of capital plays a vital role in the long-term investment decisions of firms, as it is the minimum rate of return that a firm will receive on a specific project or investment to increase the value of the stock. They connect as the market value of their shares decides the wealth of firms owners of. So the firm will invest in those specific ventures that provide more return than capital costs resulting in shareholder wealth maximization.
- What does the firm’s capital structure represent?
Sol:
Is how a company funds its overall activities and development through the use of various funding sources. Debt comes in the form of debt issues or long-term payable securities, while equity is known as, retained earnings, preferred stock, or common stock;
- What are the common sources of long-term capital available to the firm?
Sol:
Retained earnings, common stock, and long term debt.