Question

5.   Static Electric Co. currently pays a $2.10 annual cash dividend (D₀). It plans to maintain the dividend at this level for the foreseeable future as no future growth is anticipated. If the required rate of return by common stockholders (K_e) is 12 percent, what is the price of the common stock?

      

6.   The coupon rate on a debt issue is 6%. If the yield to maturity on the debt is 9%, what is the after-tax cost of debt if the firm's tax rate is 34%?

7.   The coupon rate on an issue of debt is 8%. The yield to maturity on this issue is 10%. The corporate tax rate is 31%. What would be the approximate after-tax cost of debt for a new issue of bonds?

8.   Star Corp. issued bonds 2 years ago with a 7% coupon rate. Their bonds are currently trading for $928 in the market. Which of the following most likely has occurred since the time of issue?
A. Interest rates decreased
B. Interest rates increased
C. Risk decreased
D. Real rates of return decreased

9.   A firm is paying an annual dividend of $2.65 for its preferred stock which is selling for $57.00. There is a selling cost of $3.30. What is the after-tax cost of preferred stock if the firm's tax rate is 33%?

10.       Why is the cost of debt normally lower than the cost of preferred stock?
A. Preferred stock dividends are tax deductions.
B. Interest is tax deductible.
C. Preferred stock dividends must be paid before common stock dividends.
D. Common stock dividends are not tax deductible.

Answer 1

5]

present value of perpetuity = perpetual payment / required return

price of common stock = $2.10 / 12% = $17.50

6]

after-tax cost of debt = YTM * (1 - tax rate) = 9% * (1 - 34%) = 5.94%

7]

For a new issue of bonds, the YTM and coupon rate will equal the YTM on existing debt, which is 10%.

after-tax cost of debt = YTM * (1 - tax rate) = 10% * (1 - 31%) = 6.90%

8]

B - Interest rates have increased

If a bond trades at a discount, it means that YTM > coupon rate.