Question

Lilies Corp. provided information on their capital sources as followed.

• $52,500 in Debt: Their bonds have 30-year to maturity, 4% coupon and $1,000 par value. Current bond price is $980. Tax rate is 21%.
• $157,500 in Common stocks with current price of $140, most recent dividend of $3.50, and 9% growth rate.

56) What is their after-tax cost of debt?

A.) 4.12%

B.) 3.25%

C.) 5.19%

D.) 1.56%

How much is their cost of capital?

A.) 11.28%

B.) 15.97%

C.) 9.61%

D.) 2.86%

58.) Lillies Corp considers two independent projects A and B.

Project A has $2,000 NPV while Project B has $3,500 NPV.

What should Lillies Corp do?

A.) Accept only project a since it has a lower npv

B.) Accept both projects since they both have positive NPV

C.) Reject both projects

D.) Accept only project b since it has the higher npv

Answer 1

	Par/Face value	1000
	Annual Coupon rate	0.04
	Annual coupon	40
	Present Value = Future value/ ((1+r)^t)
	where r is the yield to maturity and t is the time period in years.
	price of the bond = sum of present values of future cash flows
	price of the bond	980
	Use excel to find r
	r	0.04115
	t	1	2	3	4	5	6	30
	future cash flow	40	40	40	40	40	40	1040
	present value	38.41906	36.9006	35.44215	34.04135	32.69591	31.40365	310.1946
	sum of present values	980
	The yield to maturity for these bonds is 4.115%.
	The before-tax cost of debt	4.12%
	After-tax cost of debt	Before-tax cost of debt*(1-tc)
	where tc is the tax rate that is .21.
	After-tax cost of debt	.04115*(1-.21)
	After-tax cost of debt	0.032509
	The after-tax cost of debt is 3.25%.
56)	B) 3.25%.
	Weighted average cost of capital (WACC) = [(S/S+B)*Rs + (B/S+B)*Rb(1-tc)]
		S = equity, B = debt, Rs = Cost of equity, Rb = cost of debt,
		tc = corporations tax rate
	S	157500
	B	52500
	S/(S+B)	0.75
	B/(S+B)	0.25
	Find the cost of equity using the dividend growth model
	According to the dividend growth model
	P0 = D1/(R-g)
	where P0 is the current price of the stock that is 140.
	D1 is the most recent dividend that is 3.50.
	g is the growth rate of the dividend that is 9%.
	R is the required return of the stock
	140 = 3.50/(R - .09)
	R - .09 = 3.50/140
	R = .025 + .09
	R = .115
	The required return on the stock is the cost of equity.
	Rs = 11.5%.
	Rb*(1-tc) is the after-tax cost of debt.
	Rb*(1-tc) = 3.25%.
	WACC = .75*.115 + .25*.0325
	The WACC or the cost of capital is 9.44%.
57)	C) 9.61%.
	Since the projects are independent and not mutually exclusive, one
	project does not have to be selected over the other.	jeff jeffy Next > < Previous Related Solutions You are provided the following information: Capital Structure: Debt                                &nbsp You are provided the following information: Capital Structure: Debt                                         $    60000 Equity                                       $   180000 The firm sold 50 year; $ 1000 face value, 5% bonds 10 years ago. These bonds trade at $ 930. You expect the yield on these bonds to be a good proxy for the cost of issuing new bonds. The shares trade at $ 20; the growth rate is 6%. Dividends paid last year - $ 1.00. The firm has a 30% tax rate.... You have been provided the following information inc. debt: the market value is 50000 the bonds... 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