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 10.4%. The bonds have a current market value of $1,123 and will mature in 10 years. The firms' marginal tax rate is 34%. The cost of capital from this bond debt is? 5.63% b. A new common stock issue that paid a $1.76 dividend last year. The firm's dividends are expected to continue to grow at 6.5% per year forever. The price of the firm's common stock is now $27.86. The cost of capital from the common equity is 13.23% c. A preferred stock paying a 8.4% dividend on a $127 par value. The cost of the preferred stock is? % Round to two decimal places. d. A bond selling to yield 11.6% where the firm's tax rate is 34%.

Explanation / Answer

a) Annual coupon bond: N=10 years PMT = .104(1000) = 104 PV = -1233 FV = 1000 R = 8.52% Cost of debt = r(1-tax rate) = 8.52(1-.34) = 5.63% b) D1 = D(1+g) = 1.76(1+0.065) = 1.8744 Price = D1/(r-g) 27.86 = 1.8744/(r-0.065) r - 0.065 = 1.8744/27.86 r - 0.065 = 0.0673 r = 0.067 + 0.065 = 0.1323 Cost of common stock is 13.23% c) Cost of preferred stock is 8.4% d) selling to yield 11.6% mean YTM is 11.6% which is the cost of debt before tax Cost of debt after tax = 11.6(1-0.34) = 7.66%

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