Question

bonds: builtrite is planning on offering a $1000 par value, 20 year 8% coupon bond with an expected selling price of $1025. Flotation costs would be $55 per bond. Preferred stock: builtrite could sell a $46 par value preferred with an 8% coupon for $38 a share. Flotation costs would be $2 a share. common stock: currently the stock is selling for $62 a share and has paid a $6.82 dividend. Dividends are expectecd to continue growing at 13%. flotation costs would be $3.75 a shareand builtrite has $350,000 in avaliable retained earnings assume a 25% tax bracket. their after-tax cost of internal common (retained earnings) is:

20.62%

19.96%

19.56%

19.29%

Answer #1

Answer is 19.96%.

after-tax cost of internal common or retained earnings = [dividend paid*(1+dividend growth rate)/current share price] + dividend growth rate

dividend paid doesn't have tax shield are paid from after-tax net income. dividends can't be deducted from income before calculating taxes on it. so, after-tax and before-tax cost of internal common or retained earnings are same.

after-tax cost of internal common or retained earnings = [$3.82*(1+0.13)/$62] + 0.13 = [($3.82*1.13)/$62] + 0.13 = ($4.3166/$62) + 0.13 = 0.0696 + 0.13 = 0.1996 or 19.96%

after-tax cost of internal common or retained earnings is 19.96%.

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