1. Investors' required returns and the cost of equity capital ____ as the relative amount of debt used to finance the firm ____.
A. remain constant; increases
B. remain constant; decreases
C. increase; decreases
D. increase; increases
2. The Wagner Company tries to follow a pure "residual" dividend policy. Earnings and dividends last year were $100 million and $20 million, respectively. Anticipated earnings for this year are $80 million. The company is financed completely with common equity. The required rate of return on retained earnings is 15% while the cost of new equity is 16%. Assuming Wagner has $90 million of investment projects having expected returns greater than 16%, determine Wagner's dividend and investment policies.
A. Pay out $10 million in dividends and raise $20 million externally
B. Pay out $20 million in dividends and raise $30 million externally
C. Pay no dividends and raise $10 million externally
D. Pay no dividends and invest only in the first $80 million in projects.