Question

*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).

Answer #1

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% |

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

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