Question

Hankins Corporation has 9.4 million shares of common stock outstanding, 690,000 shares of 7.4 percent preferred stock outstanding, and 194,000 of 8.6 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $65.90 per share and has a beta of 1.39, the preferred stock has a par value of $100 and currently sells for $106.10 per share, and the bonds have 13 years to maturity and sell for 86.5 percent of par. The market risk premium is 7 percent, T-bills are yielding 5.7 percent, and the firm’s tax rate is 35 percent.

  
What is the firm's cost of each form of financing? (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

Aftertax cost of debt	%
Cost of preferred stock	%
Cost of equity	%

Answer 1

After-tax Cost of Debt

· The cost of debt for use in the WACC calculation id the after-tax Yield to maturity of the Bond

· The Yield to maturity (YTM) of the Bond is the discount rate at which the Bond’s price equals to the present value of the coupon payments plus the present value of the Face Value/Par Value

· The Yield to maturity of (YTM) of the Bond is the estimated annual rate of return expected by the bondholders for the bond assuming that the they hold the Bonds until it’s maturity period/date.

· The Yield to maturity of (YTM) of the Bond is calculated using financial calculator as follows (Normally, the YTM is calculated either using EXCEL Functions or by using Financial Calculator)

Variables	Financial Calculator Keys	Figure
Par Value/Face Value of the Bond [$1,000]	FV	1,000
Coupon Amount [$1,000 x 8.60% x ½]	PMT	43
Market Interest Rate or Yield to maturity on the Bond	1/Y	?
Maturity Period/Time to Maturity [13 Years x 2]	N	26
Bond Price/Current market price of the Bond [-$1,000 x 86.50%]	PV	-865

We need to set the above figures into the financial calculator to find out the Yield to Maturity of the Bond. After entering the above keys in the financial calculator, we get the semi-annual yield to maturity on the bond (1/Y) = 5.265%.

The semi-annual Yield to maturity = 5.265%.

Therefore, the annual Yield to Maturity of the Bond = 10.53% [5.265% x 2]

The after-tax cost of debt

The firm’s after-tax cost of debt on the Bond is the after-tax Yield to maturity (YTM)

The After-tax cost of debt = Annual Yield to maturity on the bond x (1 – Tax Rate)

= 10.53% x (1 – 0.35)

= 10.53% x 0.65

= 6.84%

Cost of Preferred Stock

Cost of Preferred Stock = (Annual Preferred dividend per share / Selling price) x 100

= [($100 x 7.40%) / $106.10] x 100

= [$7.40 / $106.10] x 100

= 6.97%

Cost of Equity

Cost of Equity = Risk-free rate + (Beta x Market risk premium)

= 5.70% + (1.39 x 7.00%)

= 5.70% + 9.73%

= 15.43%