Question

Instructions: You are required to use a financial calculator or spreadsheet (Excel) to solve 10 problems related to the cost of capital. You are required to show the following 3 steps for each problem: (i) Describe and interpret the assumptions related to the problem. (ii) Apply the appropriate mathematical model to solve the problem. (iii) Calculate the correct solution to the problem. Round all answers to two decimal places.

1. CosaNostra Pizza is undergoing a major expansion. The expansion will be financed by issuing new 24-year, $1,000 par, 6% semiannual coupon bonds. The market price of the bonds is $875 each. Flotation expense on the new bonds will be $90 per bond. The marginal tax rate is 35%. What is the post-tax cost of debt for the newly-issued bonds?

2. Fedland Inc. will issue new common stock to finance an expansion. The existing common stock just paid a $2.25 dividend, and dividends are expected to grow at a constant rate of 5% indefinitely. The stock sells for $85, and flotation expenses of 5% of the selling price will be incurred on new shares. What is the cost of new common stock?

3. YT Inc. will issue new common stock to finance an expansion. The existing common stock just paid a $2.50 dividend, and dividends are expected to grow at a constant rate of 7.5% indefinitely. The stock sells for $55, and flotation expenses of 8% of the selling price will be incurred on new shares. What is the cost of internal equity?

4. Hiro Corp. common stock is selling for $36 per share. The last dividend was $4.60, and dividends are expected to grow at a 9% annual rate. Flotation costs on new stock sales are 5% of the selling price. What is the cost of Hiro Inc.'s new common stock?

5. Enzo, Inc. has a target capital structure of 40% debt and 60% common equity, and has a 40% marginal tax rate. If the firm's before-tax cost of debt is 10% and cost of common stock is 18%, what is the firm's WACC?

6. Raven Co. expects to pay a dividend of $7.10 per share in one year. The current price of Raven common stock is $63.40 per share. Flotation costs are $5.00 per share when Raven issues new stock. What is the cost of internal common equity if the long-term growth in dividends is projected to be 4.75 percent indefinitely?

7. L. Bob Rife Company's preferred stock is currently selling for $38.00 and pays a perpetual annual dividend of $4.30 per share. New issue of preferred stock would have $6 per share in flotation costs. The firm's tax rate is 40%. Compute the cost of new preferredstock.

8. Reason Corp. just issued a series of 20-year maturity bonds with a par value of $1,000 and a 4% coupon, paid semiannually. The bonds can sell in the open market for $950. Flotation costs on the new bonds are $80. If Reason, Corp. is in the 35% tax bracket, what is the pre-tax cost of debt on the newly issued bonds?

9. Lee Airlines plans to issue 25-year bonds with a par value of $1,000 that will pay $40 every six months. The bonds have a market price of $970. Flotation costs on new debt will be 6%. If the firm is in the 35% marginal tax bracket, what is cost of new debt?

10. Fisheye Inc. is investing in a new project costing $20 million. It will raise $6 million in bonds, $4 million in preferred stock, and $10 million in retained earnings. If the after-tax cost of debt is 6%, cost of preferred stock is 10%, the cost of retained earnings is 14%, and the cost of new common stock is 18%, what is the WACC?

Answer 1

Answer:

Face Value = $1,000
Current Price = $875 - $90 = $785

Annual Coupon Rate = 6%
Semiannual Coupon Rate = 3%
Semiannual Coupon = 3%*$1,000 = $30

Time to Maturity = 24 years
Semiannual Period to Maturity = 48

Let semiannual YTM be i%

$785 = $30 * PVIFA(i%, 48) + $1,000 * PVIF(i%, 48)

Using financial calculator:
N = 48
PV = -785
PMT = 30
FV = 1000

I = 4.02%

Semiannual YTM = 4.02%
Annual YTM = 2 * 4.02%
Annual YTM = 8.04%

Before-tax Cost of Debt = 8.04%
After-tax Cost of Debt = 8.04% * (1 - 0.35)
After-tax Cost of Debt = 5.23%

Therefore, the Post tax Cost of Debt is 5.23%.