Blammo, Inc has a target capital structure of 30 debt and 70 equity. The firm is planning to
invest in a project that will necessitate raising new capital. New debt will be issued at a before-tax
yield of 14, with a coupon rate of 10.
The equity will be provided by internally generated funds
so no new outside equity will be issued. If the required rate of return on the firm's stock is 22 and
its marginal tax rate is 35, compute the firm's cost of capital.
A) 18.13 B) 19.68 C) 18.00 D) 15.55
Question 2
Which of the following statements would be consistent with the bird-in-the-hand dividend
theory?
A) Wealthy investors prefer corporations to defer dividend payments because capital gains
produce greater after-tax income.
B) Dividends are less certain than capital gains.
C) Dividends are more certain than capital gains income.
D) Investors are indifferent whether stock returns come from dividend income or capital gains
income.
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