Question

i.) Tan Co. has given out dividend payment of $23,000 and it dividend growth rate is expected to increase by 8 percent per year. The current share price is $30 and there are currently 30,000 share outstanding. What is the current cost of equity of share now.

ii.) Borneo CO. has bonds that has 10 more years to mature. Its current yield is at 8 percent and its price currently is at $90. Given its tax rate of 40 percent, what is its pretax cost of debt?

Answer 1

i]	Current cost of equity per the constant dividend growth formula = D1/P0+g
	where
	D1 = Next expected dividend
	P0 = Current price
	g = Growth rate in dividends
	Current dividend per share = 23000/30000 =	$                0.77
	Therefore, current cost of equity = 0.77*1.08/30+0.08 =	10.77%
ii]	Annual coupon = $90*8% = $7.2 or coupon rate = 7.2%.
	Pre-tax cost of debt = YTM
	YTM using the approximation formula = ((7.2+(100-90)/10)/((100+90)/2) =	8.63%
	YTM [by trial and error]:
	YTM is that discount rate which equals the PV of the
	expected cash inflows.
	Discounting with 8%:
	PV = 100/1.08^10+7.2*(1.08^10-1)/(0.08*1.08^10) =	$              94.63
	Discounting with 9%:
	PV = 100/1.09^10+7.2*(1.09^10-1)/(0.09*1.09^10) =	$              88.45
	IRR = 8%+1%*(94.63-90)/(94.63-88.45)=	8.75%
	Pre-tax cost of debt = YTM =	8.75%