Question

(Individual or component costs of capital) Compute the cost of capital for the firm for the following:

1.A preferred stock that sells for $141, pays a dividend of 8.5 percent, and has a $100 par value.

2. A bond selling to yield 10.4 percent where the firm's tax rate is 34 percent.

Answer 1

1) Cost of capital for preferred stock = (Annual dividend per share/Market value per share)*100

Annual dividend per share = Dividend rate*Par value of Preferred share

= 8.5%*$100 = $8.5

Market value per share = $141

Cost of capital for preferred stock = ($8.5/$141)*100 = 6.03%

2) For bonds, the cost of capital for the firm is after tax yield on bonds which is calculated as follows:-

Cost of capital of bonds = Yield on bond*(1-tax rate)

= 10.4%*(1-34%) = 10.4%*(1-0.34) = 6.86%