Question

Quantitative Problem: 5 years ago, Barton Industries issued 25-year noncallable, semiannual bonds with a $1,300 face value and a 5% coupon, semiannual payment ($32.5 payment every 6 months). The bonds currently sell for $845.87. If the firm's marginal tax rate is 40%, what is the firm's after-tax cost of debt? Round your answer to 2 decimal places. Do not round intermediate calculations. %

Barton Industries can issue perpetual preferred stock at a price of $47 per share. The stock would pay a constant annual dividend of $3.20 per share. If the firm's marginal tax rate is 40%, what is the company's cost of preferred stock? Round your answer to 2 decimal places.

Answer 1

Part A:

After Tax cost of debt= YTM * (1- Tax rate)

YTM = rate at which PV of Cash Unflows are equaal to Bond Price.

YTM = Rate at which least +ve NPV + [ NPV at that rate / Change in NPV due to inc of 0.5% ] * 0.5%

= 4% + [ 68.17 / 92.48 ] * 0.5%

= 4% + 0.37%

= 4.37% per six months

YTM per anum = 4.37% * 12/6

= 8.74%

Cost after tax = Debt cost * (1 - Tax rate)

= 8.74% * ( 1 - 0.4)

= 8.74% * 0.60

= 5.24%

Part B:

Kp = Pref Div / Pref stock Value

= $ 3.20 / $ 47

= 0.0681 i.e 6.81%

Taxation shield benifit is not available for Preference stock, as preference stock is below line item ( After PAT).