Billy and Co. is issuing a RM1,000 par value bond that pays 9% interest annually
ID: 2686276 • Letter: B
Question
Billy and Co. is issuing a RM1,000 par value bond that pays 9% interest annually Investor are expected to pay RM918 for the 10-year bond. Billy will have to pay RM33 per bond in flotation costs. What is cost of debt if the firm tax rate is 34%? Armadillo Mfg.Co. has a target capital structure of 50% debt and 50% equity. They are planning to invest in a project which will necessitate raising new capital. New debt will be issued at a before tax yield of 12 %, with a coupon rate of 10 %.The equity will be provided by internally generated funds. No new outside equity will be issued. If the required rate of return on the firm's stock is 15% and its marginal tax rate is 40%, compute the firm's weighted average cost of capital. Vemice Care products just paid a dividend of $1.85. This dividend is expected to grow at a constant rate of 3% per year, so the next expected dividend is $1.90. The stock price is currently $ 12.50. New stock can be sold at this price subject to floatation costs of 15%. The company's tax rate is 40%. Compute the cost of internal (retained) earnings and the cost of external equity( new common stock).Explanation / Answer
Ans with details: Capital is a term used in the field of financial investment to refer to the cost of a company's funds (both debt and equity), or, from an investor's point of view "the shareholder's required return on a portfolio company's existing securities".[1] It is used to evaluate new projects of a company as it is the minimum return that investors expect for providing capital to the company, thus setting a benchmark that a new project has to meet. 2)Cost of equity Cost of equity = Risk free rate of return + Premium expected for risk Cost of equity = Risk free rate of return + Beta x (market rate of return- risk free rate of return) where Beta= sensitivity to movements in the relevant market E_s = R_f + eta_s(R_m - R_f)., Where: Es The expected return for a security Rf The expected risk-free return in that market (government bond yield) ßs The sensitivity to market risk for the security RM The historical return of the stock market/ equity market (RM-Rf) The risk premium of market assets over risk free assets. The risk free rate is taken from the lowest yielding bonds in the particular market, such as government bonds. An alternative to the estimation of the required return by the CAPM as above, is the use of the Fama–French three-factor model. 3) Expected return The expected return (or required rate of return for investors) can be calculated with the "dividend capitalization model", which is K_{cs} = rac{Dividend_{Payment/Share}} {Price_{Market}} + Growth_{rate}., Comments The models state that investors will expect a return that is the risk-free return plus the security's sensitivity to market risk times the market risk premium. The risk premium varies over time and place, but in some developed countries during the twentieth century it has averaged around 5%. The equity market real capital gain return has been about the same as annual real GDP growth. The capital gains on the Dow Jones Industrial Average have been 1.6% per year over the period 1910-2005. [2] The dividends have increased the total "real" return on average equity to the double, about 3.2%. The sensitivity to market risk (ß) is unique for each firm and depends on everything from management to its business and capital structure. This value cannot be known "ex ante" (beforehand), but can be estimated from ex post (past) returns and past experience with similar firms. Cost of retained earnings/cost of internal equity Note that retained earnings are a component of equity, and therefore the cost of retained earnings (internal equity) is equal to the cost of equity as explained above. Dividends (earnings that are paid to investors and not retained) are a component of the return on capital to equity holders, and influence the cost of capital through that mechanism. Weighted average cost of capital
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