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%