Question

Market Info:- Real interest rate = 2.0%; Expected inflation = 4.0%; Rm = 12.0%; Tax = 30.0%.

Com. Stock info:- Par value = $1.0 ; Market value (price) = ?? ; Beta = 1.60 ; No. of outstanding shares = 1,000,000.0 ; EPS $3.0 ; pay-out ratio = 30.0%;

Growth in EPS & Dividends = 5.0% ;

Preferred Stock info:- Par value = $100.0; Dividend per share = 10.0%; Rp=8.0%; No. of outstanding shares = 100,000.0; Price = ????

Bonds info:- Par value = $1,000.0; Coupon interest = 4.0% ; YTM = 6.0%; Time to maturity = 20 years ; No. of bonds = 100.0; Price = ???

1 - The before and after tax cost of debt.

2 -The before and after tax cost of equity.

3 - The before and after tax cost of preferred stock.

Answer 1

1. Before tax cost of debt= ytm

= 6%

After tax cost of debt= ytm (1-tax rate)

= 6% (1- 0.30)

= 6% (0.70)

= 4.2%

Using financial calculator to calculate price of the bond

Inputs: N= 20

I/y= 6%

Pmmt= 4% × 1,000 = 40

Fv= 1,000

Pv= compute

We get, price of the bond as $770.60

2. Cost of equity= risk free rate + beta ( market return - risk free rate)

= (2% + 4%) + 1.60 ( 12% - (2% + 4%))

= 6% + 1.60 ( 12% - 6%)

= 6% + 1.20 (6%)

= 6% + 7.2%

= 13.2%

After and before tax cost of equity = 13.2%

Dividend= EPS × payout ratio

= 3 × 0.3

= 0.9

Price = Dividend (1 + growth rate) / Cost of equity - growth rate

= 0.9 (1+0.05) / 0.132 - 0.05

= 0.9 (1.05) / 0.082

= 0.945 / 0.082

= $11.52

3. After and before tax cost of preferred stock = 8%

Price = Dividend / return on preference share

= 10% × 100/ 0.08

= 10 / 0.08

= $125