Question

XYZ Corporation . is issuing a $1,000 par value bond that pays 9% interest annually. Investors...

XYZ Corporation . is issuing a $1,000 par value bond that pays 9% interest annually. Investors are expected to pay $985 for the 10-year bond. Bender and Co. can expect to pay an additional risk premium of 4.2% on common stock. What is the firm's cost of equity capital?.

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Answer #1

Cost of the Bond is the YTM of the bond:

You need to use Financial calculator to solve this problem. You can download it.

N = 10 (The bond is issued for 10 years)

PV = 985 (The present value of the bond is $985)

PMT = -90 (9% of $1,000 is what the firm will pay each year to the bondholders)

FV= -1,000 (At the end of 10 years the firm will have to pay back $1,000)

CPT + I/Y = 9.2361

So the YTM of the bond issued is 9.2361%

The cost of equity as said in the problem is = YTM of BOND + Risk Premium

= 9.2361 + 4.2

= 13.4361

So the cost of Equity capital is 13.4361%

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