Question

# Individual or component costs of capital​) Compute the cost of the​ following: a. A bond that...

Individual

or component costs of

capital​)

Compute the cost of the​ following:

a. A bond that has

​\$1,000

par value​ (face value) and a contract or coupon interest rate of

11

percent. A new issue would have a floatation cost of

6

percent of the

​\$1115

market value. The bonds mature in

9

years. The​ firm's average tax rate is 30 percent and its marginal tax rate is

33

percent.

b. A new common stock issue that paid a

​\$1.60

dividend last year. The par value of the stock is​ \$15, and earnings per share have grown at a rate of

8

percent per year. This growth rate is expected to continue into the foreseeable future. The company maintains a constant​ dividend-earnings ratio of 30 percent. The price of this stock is now

​\$25

but

5

percent flotation costs are anticipated.

c. Internal common equity when the current market price of the common stock is

​\$45

The expected dividend this coming year should be

​\$3.20

increasing thereafter at an annual growth rate of

8

percent. The​ corporation's tax rate is

33

percent.

d. A preferred stock paying a dividend of

12

percent on a

​\$150

par value. If a new issue is​ offered, flotation costs will be

9

percent of the current price of

​\$163

e. A bond selling to yield

12

percent after flotation​ costs, but before adjusting for the marginal corporate tax rate of

33

percent. In other​ words,

12

percent is the rate that equates the net proceeds from the bond with the present value of the future cash flows​ (principal and​ interest).

 a) Before tax cost of debt = YTM. Face value = \$1000, MV = \$1000, n = 9 years, Realizable market price = \$1115*(1-6%) = \$1048.10, Coupon = 11%. YTM (using an online calculator) = 10.16% After tax cost of debt (using marginal rate of tax) = 10.16%*(1-33%) = 6.81% After tax cost of debt (using average rate of tax) = 10.16%*(1-30%) = 7.11% b) Cost of new common stock (using constant dividend trowth model) = 1.60*1.08/(25*95%)+0.08 = 15.28% c) Cost of internal common equity (using constant dividend growth model) = 3.2/45+0.08 = 15.11% d) Cost of preferred stock = 150*12%/(163*91%) = 12.14% e) After tax cost of debt = 12%*(1-33%) 8.04%

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