Compute the cost of capital for the firm for the following: a. A bond that has a

Question

Compute the cost of capital for the firm for the following:

a. A bond that has a $1,000 par value (face value) and a contract or coupon interest rate of 11.9 percent. Interest payments are $59.50 and are paid semiannually. The bonds have a current market value of $1,122 and will mature in 10 years. The firm’s marginal tax rate is 34 percent.

b. A new common stock issue that paid a $1.84 dividend last year. The firm’s dividends are expected to continue to grow at 6.5 percent per year, forever. The price of the firm’s common stock is now $27.69.

c. A preferred stock that sells for $144, pays a dividend of 8.9 percent, and has a $100 par value.

d. a Bond selling to yield 11.4 percent where the firm’s tax rate is 34 percent.

a. The after-tax cost of debt is ____% (Round to two decimal places)

b. The cost of common equity is ____% (Round to two decimal places)

c. The cost of preferred stock is ____% (Round to two decimal places)

d. The after-tax cost of debt it ____% (Round to two decimal places)

Explanation / Answer

Question a. Semi annual interest 59.5 Annual Interest payment 119 Less: Tax Savings 40.46 Net Interest payment 78.54 Market value of bond 1122 Cost of Debt = 78.54/1122 7.00% Question b. Last year dividend 1.84 Growth rate 6.50% Current years Expected Dividend (1.84 x 1.065) 1.9596 Market price of stock 27.69 Cost of Commo equity (1.9596/27.69) 7.08% Answer: 7.08% Question c. Cost of Preferred stock = 8.9/144 = 6.18% Answer: 6.18% Question d. Bond yield 11.40% Less:Tax @ 34% on yield 3.88% Net Yield after Tax 7.52% Answer: 7.52%

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