A firm currently has the following capital structure which it intends to maintai

Question

A firm currently has the following capital structure which it intends to maintain. Debt: $1,250,000 par value of 7.25% bonds outstanding with an annual before-tax yield to maturity of 6.50% on a new issue. The bonds currently sell for $115 per $100 par value. Common stock: 23,000 shares outstanding currently selling for $45 per share. The firm's beta is 1.75. The rate on 3-month U.S. Treasury bill is 3.50%, and the return on the S & P 500 index is 12.25%. The firm's marginal tax rate is 34%. The company has no plans to issue new securities. The after-tax cost of common stock is:

Please show your work

Explanation / Answer

Risk free Rate = rate on 3-month U.S. Treasury bill = 3.5%

Return from Market = return on the S & P 500 index = 12.25%

After tax cost of common stock = Risk free return + (Return from market - Risk free return)* Beta

                                                  = 3.5 + (12.25-3.5)*1.75

                                                  = 0.1881

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