ABC has the following market value capital structure, shown below, which is considered to be optimal. The firm has no preferred stock.
Debt $400,000
Equity $600,000
New bonds currently have a 10% coupon rate and ABC's stock sells for $20 per share. The expected growth rate in dividends is 8 percent. The corporate tax rate is 40 percent and the firm net income was $5 million. Finally, the firm paid 20% of its earning out as dividends.
a. What is the firm cost of capital?
b. If the flotation cost is 10%, how much capital can the firm raise before its marginal cost of capital increases? What is the new cost of capital?