Question

​(Individual or component costs of​ capital) Compute the cost of capital for the firm for the​ following

a.  A bond that has a $1,000 par value​ (face value) and a contract or coupon interest rate of 10.1 percent. Interest payments are $50.50 and are paid semiannually. The bonds have a current market value of $1,130 and will mature in 10 years. The​ firm's marginal tax rate is 34 percent.

b.  A new common stock issue that paid a

​$1.77 dividend last year. The​ firm's dividends are expected to continue to grow at 6.5 percent per​ year, forever. The price of the​ firm's common stock is now ​$27.61.

c.  A preferred stock that sells for

​$121​, pays a dividend of 8.5 percent, and has a​ $100 par value.  

d.  A bond selling to yield 12.4 percent where the​ firm's tax rate is 34 percent

What is:

a. The after-tax cost of debt

b. The cost of common equity

c. The cost of preferred stock

d. The after-tax cost of debt

Answer 1

a)

Number of periods = 10 * 2 =20

YTM = 8.1723%

Keys to use in a financial calculator:

2nd P/Y 2

FV 1000

PV -1,130

N 20

PMT 50.50

CPT /Y

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

After tax cost of debt = 0.081723 (1 - 0.34)

After tax cost of debt = 0.0539 or 5.39%

b)

Year dividend = 1.77 (1+ 6.5%) = 1.88505

Cost of common equity = (D1 / price) + growth rate

Cost of common equity = (1.88505 / 27.61) + 0.065

Cost of common equity = 0.068274 + 0.065

Cost of common equity = 0.1333 or 13.33%

c)

Annual dividend = 8.5% of 100 = 8.5

Cost of preferred stock = (Annual dividend / price) * 100

Cost of preferred stock = (8.5 / 121) * 100

Cost of preferred stock = 7.02%

d)

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

After tax cost of debt = 0.124 (1 - 0.34)

After tax cost of debt = 0.0818 or 8.18%