Question

(Individual or component costs of capital​)

Compute the cost of the​ following:

a. A bond that has $1,000 par value​ (face value) and a contract or coupon interest rate of 9 percent. A new issue would have a floatation cost of 6 percent of the ​$1,140market value. The bonds mature in 14 years. The​ firm's average tax rate is 30 percent and its marginal tax rate is 24 percent.

b. A new common stock issue that paid a ​$1.40 dividend last year. The par value of the stock is​ $15, and earnings per share have grown at a rate of 11 percent per year. This growth rate is expected to continue into the foreseeable future. The company maintains a constant​ dividend-earnings ratio of 30 percent. The price of this stock is now $31, but 7 percent flotation costs are anticipated.

c. Internal common equity when the current market price of the common stock is ​$42. The expected dividend this coming year should be $3.10​, increasing thereafter at an annual growth rate of 9 percent. The​ corporation's tax rate is 24 percent.

d. A preferred stock paying a dividend of 8 percent on a ​$110 par value. If a new issue is​ offered, flotation costs will be 13 percent of the current price of ​$166.

e. A bond selling to yield 9 percent after flotation​ costs, but before adjusting for the marginal corporate tax rate of 24 percent. In other​ words, 9 percent is the rate that equates the net proceeds from the bond with the present value of the future cash flows​ (principal and​ interest).

a. What is the​ firm's after-tax cost of debt on the​ bond?

Answer 1

	a	Market Value of new bond	$1,140
		Flotation cost =6%*1140	$68.40
	Pv	Amount received per bond	$1,071.60
	Nper	Number of years to maturity	14
	Pmt	Annual coupon payment=1000*9%	$90
	Fv	Payment at maturity	$1,000
	RATE	Before tax cost of new bond	8.13%
		(Using excel RATE function)
		After tax cost of debt =8.13*(1-0.24)	6.18%
	b	Since there is constnt dividend earning ratio:
		g=Dividend growth rate	11%	0.11
		Next years dividend =D1=$1.40*1.11	$1.55
		Current Price=P0=D1/(R-g)
		R=Required Return on Equity
		P0=$31
		31=1.55/(R-0.11)
		R=Required Return on Equity=(1.55/31)+0.11=	0.1600
		Required return on equity	16.00%
		Flotation cost=7%
		Cost of New Equity =16/(1-0.07)=	17.20%
	c	Internal Common Equity
		P0=$42
		D1=$3.10
		g=9%=0.09
		Required Return=R=(D1/P0)+g=(3.1/42)+0.09=	0.1638095
		Cost of internal equity	16.38%
	d	Dividend per share =8%*110	$8.80
		Market Price	$166
		Flotation Cost=166*13%=	$21.58
		Net amount received per share =166-21.58	$144.42
		Cost of new issue=8.8/144.42=	6.09%
	e	After tax cost of the bond=9*(1-Tax Rate)	6.84%	(9*(1-0.24)