Question

Curro Holdings Ltd has a target capital structure that calls for 25% debt, 25% preferred stock, 50% common equity. The firm's before-tax cost of debt is 8.34%, the tax rate 40% and it can sell as much debt as it wishes at this rate. The firm's prefered stock currently sells for R80 per share and pays a perpetual dividend of R2.9. The firm will, however only net R68 per share from the sale of new preferred stock. It's common share currently sells for R50 per share. The firm's beta is 0.7, and the market risk premium is 13.74%. The risk-free rate is 5.09%.

a) Find the firm's cost of common shares.
B) find the newly issued prefered shares
C) find the after-tax component cost of debt

Answer 1

a)

Cost of common shares = Risk free rate + beta(market risk premium)

Cost of common shares = 5.09% + 0.7(13.74%)

Cost of common shares = 5.09% + 9.618%

Cost of common shares = 14.71%

b)

Cost of newly preferred shares = (Annual dividend / price) * 100

Cost of newly preferred shares = (2.9 / 68) * 100

Cost of newly preferred shares = 4.26%

c)

After tax cost of debt = Before tax cost of debt (1 - tax)

After tax cost of debt = 0.0834 (1 - 0.4)

After tax cost of debt = 0.05 or 5%