Crypton Electionics has a capital structure consisting of 38% common stock and 6

Question

Crypton Electionics has a capital structure consisting of 38% common stock and 62% debt. A debt issue of $1,000 par value, 6.1% bonds that mature in 15 years and pay annual interest will sell for $978.00. Common stock of the firm is currently selling for $29.46 per share and the firm expects to pay a $2.23 dividend next year. Dividends have grown at a rate of 5.2% per year and are expect to continue to do so for the foreseeable future. What is Crypton's cost of capital where the firm's tax rate is 30%? Cryption's cost of capital is _______% (Round to three decimal places)

Explanation / Answer

Cost of equity = D0(1+g)/P0 + g

Cost of equity = (2.23) (1+0.052)/29.46 + 0.052 = 0.1316

Cost of debt

Cashflows:

Year 0: -1000

Year 1 - 15 Interest: 1000 x 6.1% x 0.7 = $42.7

Year 15: Redemption value = $978

As the debt is redeemable, its cost has to be estimated using the IRR method:

At discount rate of 5%,

PV = -1000 + 42.7 x 10.38 + 978 x 0.481 = -86.4

At discount rate of 3%

PV = -1000 + 42.7 x 11.94 + 978 x 0.642 = +137.7

Cost of debt after tax = 3% + (137.7/137.7 + 86.4) x 2% = 4.2%

Weighted average cost of capital = 0.38 x 0.1316 + 0.62 x 0.0042 = 5.261%

Hope this helps!

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