Question

​(Individual or component costs of​ capital)  Compute the cost of capital for the firm for the​ following:

a.  Currently bonds with a similar credit rating and maturity as the​ firm's outstanding debt are selling to yield

7.237.23

percent while the borrowing​ firm's corporate tax rate is

3434

percent.

b.  Common stock for a firm that paid a

​$1.041.04

dividend last year. The dividends are expected to grow at a rate of

5.75.7

percent per year into the foreseeable future. The price of this stock is now

​$24.5824.58.

c.  A bond that has a

​$1 comma 0001,000

par value and a coupon interest rate of

11.411.4

percent with interest paid semiannually. A new issue would sell for

​$1 comma 1491,149

per bond and mature in

2020

years. The​ firm's tax rate is

3434

percent.

d.  A preferred stock paying a dividend of

7.47.4

percent on a

​$9090

par value. If a new issue is​ offered, the shares would sell for

​$83.0783.07

per share.

Answer 1

a.
	After tax cost of debt (bond)	=	Before tax cost of debt*(1-Tax rate)
		=	.0723*(1-.34)
		=	4.77%
b.	Cost of Common equity	=	((D0*(1+g))/P0)+g	Where,
		=	((1.04*(1+.0575))/24.58)+.0575	D0	=	Dividend of last year
		=	10.22%	g	=	Growth rate
				P0	=	current price
c.	After Tax cost of debt	=	4.74%
	Working:
	Coupon semi annually	=	Par Value*coupon Rate*6/12
		=	1000*11.41%*6/12
		=	$ 57.05
	Period (Semi annual)	=	Years*compounding each year
		=	20*2
		=	40
	Before tax cost of debt	=	Average Income/Average Investment
	(semi annual)	=	((Coupon Interest+((Par Value-Current Price)/period))/((Par Value+Current Price)/2))
		=	((57.05+((1000-1491)/40))/((1000+1491)/2))
		=	3.59%
	Annual Before tax cost of debt	=	3.59%*2
		=	7.18%
	After Tax cost of debt	=	Before tax cost of debt*(1-Tax Rate)
		=	7.18%*(1-.34)
		=	4.74%
d.	Cost of preferred Stock	=	Dividend/Issue Price
		=	6.66/83.07
		=	8.02%
	Working:
	Dividend	=	Par Value*dividend Rate
		=	90*7.4%
		=	6.66