Question

Adams Corporation's present capital structure, which is also its target capital structure is

Answer 1

Answer:

Task a:

The answer is $24,500.

Task b:

The answer is 17%

Explanation:

Task a:

What is the maximum amount of new capital that can be raised at the LOWEST  component cost of EQUITY?

Solution:

We already know the following:

Projected net income = $21,000

Payout ratio = 30%

Retention ratio = 70%

Debt share = 40%

Equity share = 60%

Maximum amount of capital to be raised at the lowest component cost of equity = Projected net income ×$\frac{Retention ratio}{Equity share}$

= $21,000 × $\frac{0.70}{0.60}$

= $24,500

Answer:

The maximum amount of new capital that can be raised at the lowest component of equity is $24,500.

Task b:

What is the component cost of equity by selling new common stock?

Solution:

k(e) (component cost of external equity) = [Dividend (D0)(1 + growth) / stock price(1 - flotation cost)] + growth

Formula:

k(e) = $\frac{Do(1+g)}{P(1-0.20)}$ + 0.05

Where

Do = $2.00

G = 0.05

P = $21/88

= ($2.00(1 + 0.05) / $21.88(1-.20)) + 0.05

= ($2.10/$21.88(1-.20)) + 0.05

= ($2.10/$21.88(0.80) + 0.05

= 0.17 or 17%

Answer:

The component cost of equity by selling new common stock = 17%