The Killington Corporation has planned capital expenditures of $40 million for t

Question

The Killington Corporation has planned capital expenditures of $40 million for the upcoming fiscal year. Killington's stock is currently selling at $22 per share. Flotation costs are 10%. The earnings growth rate has been steady and is expected to continue. The last dividend paid was $0.97 per share and is expected to grow at a rate of 9%. The company tax rate is 40%. The Mortgage bonds are currently selling for $1,073.61. The bonds are 7%, $1,000 par and pay interest annually. They will mature in 10 years.

Compute the after-tax cost of each component of capital.

a) Bonds

b) Retained Earnings

c) New Common Stock

Explanation / Answer

Hi,

Please find the detailed answer as follows;

Part A: Bonds

Nper = 10 (indicates the period)

FV = 1000 (indicates the face value of bonds)

PV = 1073.61 (indicates the current sales price of bonds)

PMT = 1000*7% = 70 (indicates the amount of annual interest rate)

Rate = ? (indicates the cost of bonds)

After Tax Cost of Bonds = Rate(Nper,PMT,PV,FV)*(1-Tax Rate) = Rate(10,70,-1073.61,1000)*(1-.40) = 3.60%

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Part B: Retained Earnings

Cost of Retained Earnings = D1/Current Shares Price + Growth Rate = .97*(1+.09)/22 + .09 = 13.81%

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Part C: Common Stock

Cost of Common Stock = D1/Current Shares Price after Floatation Cost + Growth Rate = .97*(1+.09)/(22 - .10*22) + .09 = 14.34%

Thanks.

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