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

9

percent. A new issue would have a floatation cost of

9

percent of the

​$1,130

market value. The bonds mature in

15

years. The​ firm's average tax rate is 30 percent and its marginal tax rate is

35

percent.b. A new common stock issue that paid a

​$1.80

dividend last year. The par value of the stock is​ $15, and earnings per share have grown at a rate of

11

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

​$24​,

but

9

percent flotation costs are anticipated.c. Internal common equity when the current market price of the common stock is

​$49.

The expected dividend this coming year should be

​$3.50​,

increasing thereafter at an annual growth rate of

7

percent. The​ corporation's tax rate is

35

percent.d. A preferred stock paying a dividend of

11

percent on a

​$150

par value. If a new issue is​ offered, flotation costs will be

12

percent of the current price of

​$175.

e. A bond selling to yield

11

percent after flotation​ costs, but before adjusting for the marginal corporate tax rate of

35

percent. In other​ words,

11

percent is the rate that equates the net proceeds from the bond with the present value of the future cash flows​ (principal and​ interest).

a. What is the​ firm's after-tax cost of debt on the​ bond?

nothing ​%

​(Round to two decimal​ places.)

b. What is the cost of external common​ equity?

nothing ​%

​(Round to two decimal​ places.)

c. What is the cost of internal common​ equity?

nothing ​%

​(Round to two decimal​ places.)

d. What is the cost of capital for the preferred​ stock?

nothing ​%

​(Round to two decimal​ places.)

e. What is the​ after-tax cost of debt on the​ bond?

nothing ​%

​(Round to two decimal​ places.)

Answer 1

a. The par value of bond is $1000,

The PV after adjustment of floatation costs is

$1130 - (9% *1130)

=( $1028.3)

PMT = $90

N= 15 YEARS

So, I/Y = 8.656

After tax cost of debt is :

8.656*0.65

=5.63% (rounded off to two decimal places)

b. The cost of equity is :

Re = D1 /Po + G

D1 = Dividends paid next year

P0 = current stock price

g= growth rate

Dividends = 1.8

dividend payout ratio is 30%

earnings is $6

earnings are expected to rise by 11%

so, earnings next year is $6.66

dividend is 30% of earnings which is $1.998

Po = $24( 1- 0.09)

G = 11%

So,

Re = 1.998/ $21.84 + 0.11

=20.15%

c. Re = D1/ Po + g

= 3.5/49 + 0.07

=14.14%

d. Cost of preferred stock is :

Dividend paid / Price of preferred stock after floatation costs

= 0.11*150/ 175( 1- 012)

=16.5/154

=10.71%

e. The yield o the bond is 11%

The marginal tax rate is 35%

The after tax cost of debt is = 11% *0.65

=7.15%