Question

JG Enterprises has 50 million shares, trading at $4 a share; the cost of equity is 12%. It has debt with a market value of $ 100 million and a pre-tax cost of debt of 6%. Finally the company has $100 million in market value of preferred stock; the preferred shares are trading at $80 a share, with an annual preferred dividend of $6/share. If the marginal tax rate is 40%, estimate the cost of capital for the firm

a. 9.88%

b. 8.78%

c. 6.56%

d. 12.32%

Answer 1

Answer:8.78%

Cost of capital for the firm=Cost of Equity*%of equity+%of preferred stock*Cost of preferred stoc+After tax cost of debt8%of debt

Here the total capital =50,000,000*$4=$200,000,000 + Debt =$100,000,000 + Preferred Stock =$100,000,000 That's $400,000,000

%of equity =200,000,000/400,000,000=0.5

%of debt=$100,000,000/$400,000,000=.25

%of preferred stock =$100,000,000/$400,000,000=.25

Cost of Equity given as 12% Cost of preferred stock=Dividend /Price=6/80=.075 that's 7.5%

After tax Cost of debt= .06*(1-.4)=0.036 That's 3.6%

Cost of capital =0.5*0.12+0.25*0.036+0.25+0.075=0.08775 that's 8.78%(rounded to two decimals)