Question

Please show work, thank you in advance.

What is the component cost of equity capital for a stock selling for $50, that is expected to pay a dividend of $4 next year, with an expected constant growth rate of 12%?  

1. 16%
2. 12%
3. 20% (correct)
4. 8%

Thorton Corp. plans to finance a $1 million project with 30% debt and 70% equity. The before tax cost of debt is 8%; the cost of equity is 20%. Thorton's tax rate is 40%. Calculate the weighted average cost of capital (WACC).

1. 28%
2. 16.4%
3. 20%
4. 15.44% (correct)

The after-tax cost to a company with a tax rate of 40% of 8% coupon bonds sold to yield 9% is:

1. 9%.
2. 4.8%.
3. 3.6%.
4. 5.4%. (correct)

What is the after-tax component cost of a $7 dividend, $100 par, preferred stock issued years ago, but selling for $85 today? The are no flotation costs. The company's tax rate is 40%.

1. 7%
2. 8.24% (correct)
3. 4.94%
4. 8.45%

Answer 1

1) Cost of equity capital = (D1 / P0) + g

Cost of equity capital = ($4/$50) + 0.12

Cost of equity capital = 0.20 or 20%

2) WACC = [Weight of debt * Pretax cost of debt(1 - Tax rate)] + (Weight of equity * Cost of equity)

WACC = [0.30 * 0.08(1 - 0.40)] + (0.70 * 0.20)

WACC = 0.1544 or 15.44%

3) After tax cost of debt = Pretax cost of debt(1 - Tax rate)

After tax cost of debt = 0.09(1 - 0.40)

After tax cost of debt = 0.054 or 5.4%

4) Cost of preferred stock = Dividend / Price

Cost of preferred stock = $7 / $85

Cost of preferred stock = 0.0824 or 8.24%