Question

(Weighted average cost of capital) Bane Industries has a capital structure consisting of 61 percent common stock and 39 percent debt. The firm's investment banker has advised the firm that debt issued with a $1 comma 000 par value, 8.1 percent coupon (interest paid semiannually), and maturing in 20 years can be sold today in the bond market for $1 comma 087. Common stock of the firm is currently selling for $80.09 per share. The firm expects to pay a $1.93 dividend next year. Dividends have grown at the rate of 7.9 percent per year and are expected to continue to do so for the foreseeable future. What is Bane's average cost of capital where the firm faces a tax rate of 34 percent?

a. The after-tax cost of debt is nothing%. (Round to two decimal places.)

b. The cost of common equity is nothing%. (Round to two decimal places.)

c. Bane's average cost of capital is nothing%. (Round to three decimal places.)

Answer #1

A. The after tax cost of debt is :

FV= $1000

PV = ($1087)

PMT = $40.5

N= 40 YEARS

SO, I/ Y is = 7.27 (3.63*2)

SO, the after tax cost of debt is = 7.27%*( 1- 0.34)

= 4.7982%

= 4.8% (rounded off to two decimal places)

Cost of equity :

Re = D1/Po + g

= $1.93/ 80.09 + 0.079

= 10.3098%

= 10.31 % (rounded off to two decimal places)

The WACC IS :

WEIGHT OF DEBT * COST OF DEBT + WEIGHT OF EQUITY * COST OF EQUITY:

= 0.39 *0.048 +0.61 *0.1031

=0.0187 + 0.0629

= 8.1591 %

= 8.159% (ROUNDED OFF TO THREE DECIMAL PLACES)

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