Question

Question 1) David Abbot is interested in purchasing a bond issued by Sony. He has obtained the following information on the security:

Par Value: $1000

Coupon Interest Rate: 8%

Corporate Tax Rate: 30%

Cost: $930

Years to Maturity: 10

Answer the following parts:

a) Calculate the before-tax cost of the Sony bond using the bond's Yield to Maturity (YTM)

b) Calculate the after-tax cost of the Sony bond given the corporate tax rate.

Question 2)

Lang Enterprises is interested in measuring its overall cost of capital. Current investigation has gathered the following data.  The firm is in the 30% tax bracket.

DEBT: The firm can raise debt by selling $1,000 par value, 9% coupon interest rate, 17 year bonds on which annual interest payments will be made.  To sell the issue, an average discount of $25 per bond would have to be given. The firm also must pay flotation costs of $15 per bond.

PREFERRED STOCK: The firm can sell 8.5% preferred stok at its $105 per share par value.  the cost of issuing and selling the preferred stock is expected to be $7 per share. Preferred stock can be sold under these terms.

COMMON STOCK:  The firm's common stock is currently selling for $65 per share.  The firm expects to pay cash dividends of $7.5 per share next year.  The firm's dividends have been growing at an annual rate of 8% and this growth is expected to continue into the future.  The stock must be underpriced by $6 per share, and flotation costs are expected to amount to $6 per share.  The firm can sell new common stock under these terms.

RETAINED EARNINGS: When measuring this cost, the firm does not have concern itself with the  tax racket or brokerage fees of owners.  It expects to have available $100,000 of retained earnings in the coming year'; once these retained earnings are exhausted, the firm will use new common stock as the form of common stock equity financing.

a. Calculate the after-tax cost of debt.

b. Calculate the cost of preferred stock.

c. Calculate the cosst of common stock,.

d Calculate the firm's weighted average cost of capital using he capital structure weights shown in teh following table. (Round answer to the nearest 0.1%)

Source of Capital                                              Weight

Long-Term Debt                                        35%

Preferred Stock 10

Common Stock Equity                               55

Total                                                              100%

THANK YOU!!!

Answer 1

Formula Sheet

A1	B	C	D	E	F	G	H	I	J	K	L
2		a)
3		Calculation of Yield to maturity:
4		Face value	1000
5		Coupon rate	0.08
6		Current Price	930
7		Years to Maturity	10	years
8		Annual Coupon	=D4*D5	=D4*D5
9		Cash flow to investor will be as follows:
10		Year	0	1	2	3	4	5	..	=D7
11		Cash flow	=-D6	=D8	=E11	=F11	=G11	=H11	=I11	=J11+D4
12
13		Yield to maturity is the rate at which if future NPV to Investor will be zero.
14		Let r be the yield to maturity then,
15
16
17
18
19
20
21
22		By solving above equation, yield to maturity r can be found.
23		Hit and trial method can be used to find the solution of above equation.
24
25		Rate(nper,pmt,PV, [fv],type) function of excel can be used to find the yield to maturity as follows:
26		NPER	=D7
27		PMT	=D8
28		PV	=-D6
29		FV	=D4
30
31		Yield to maturity	=RATE(D26,D27,D28,D29)	=RATE(D26,D27,D28,D29)
32
33		Thus yield to maturity is	=D31
34
35		b)
36
37		Before tax Yield to maturity	=D33
38		Tax Rate	0.3
39		After Tax Cost of Debt	=Cost of debt*(1- Tax rate)
40			=D37*(1-D38)	=D37*(1-D38)
41
42		Hence after-tax cost of debt is	=D40
43