breakpoint RE = retained earnings / weight common equity
$450m(1 - 0.50) / 0.60
= $225m / 0.60
= $375m <"D"
2. Yes, b/c the breakpoint is lower than their capital needs.
The breakpoint represents the amount of capital that can be raised before new common equity must be issued in order to retain the target weights (of the capital structure) in their WACC (Weighted Average Cost of Capital).
3. Cost of external (new) equity "kc"...
kc = [D1 / (P0*(1 - float))] + g,
where D1 = the next dividend, P0 = price at t=0, float = %cost of float in decimal form, and g = growth rate in decimal form...
kc = [2.10 / (24(1 - 0.10))] + 0.055
= [2.10 / (24(0.90))] + 0.055
= (2.10 / 21.60) + 0.055
= 0.09722 + 0.055
= 0.15222, or 15.22%
1. Yohe inc. forecasts net income of $450 million next year; it plans to pay out 50% of its earnings as dividends and retain the rest. The firm's capital structure consists of 35% debt, 5% preferred stock, and 60% common equity. What is Yohe's retained earnings (RE) breakpoint?
A. $300 million
B. $325 million
C. $350 million
D. $375 million
E. $400 million
2. Yohe's forecasted capital budget requires $425 million of investment next year. Does the firm need to issue new common stock to fund next year's capital budget?
A. Yes
B. No
3. Suppose Yohe needed to issue new stock to fund this year's new capital budget. The stock will be sold to the investors at the current market price of $24 per share; it is still expected to pay a dividend of $2.10 per share at the end of the year at grow at a constant rate of 5.5%. However, the flotation cost associated with the new stock issue is expected to equal 10% of the stock's selling price. What is the firm's cost of new common stock, re?
A. 15.69%
B. 14.35%
C. 14.73%
D. 15.22%
E. 16.25%
