Compute the cost of capital for the firm for the following: Currently bonds with
ID: 2730617 • Letter: C
Question
Compute the cost of capital for the firm for the following: Currently bonds with a similar credit rating and maturity as the firm's outstanding debt are selling to yield 8 percentage while the borrowing firm's corporate tax rate is 34 percentage. Common stock for a firm that paid a dollar 1.05 dividend last year. The dividends are expected to grow at a rate of 5 percentage per year into the foreseeable future. The price of this stock is now dollar 25. A bond that has a dollar 1,000 par value and a coupon interest rate of 12 percentage. A new issue would sell for dollar 1,150 per bond and mature in 20 years. The firm's tax rate is 34 percentage. A preferred stock paying a 7 percentage dividend on a dollar 100 par value. If a new issue is offered, the shares would sell for dollar 85 per share.Explanation / Answer
a.
After tax debt for bond A = 8% (1 -.34)
= 8% * 0.66
= 5.28%
b.
Cost of common stock =[ D0( 1 +g) / price ] +g
= [1.05 (1 +0.05) / 25 ] + 0.05
= [1.05 *1.05 /25] +0.05
=[ 1.1025 /25 ] +0.05
= 0.0441 +0.05
= 0.0941 or 9.41%
c.
Yield to maturity = [semiannual interest + (face value -price)/years ] /[(face value +price)/2]
= [60 + (1000 -1150 ) /40 ] /[(1000+1150)/2]
= [60 + ( -150 /40) ] / [2150/2]
= [60 - 3.75 ] / 1075
= 56.25 /1075
= 5.23 % semiannually or 5.23*12/6 = 10.46 % annually
Yield on bond B after tax= 10.46 (1 - 0.34)
= 10.46 * 0.66
= 6.90 %
**Semiannual interest = 1000*12% *6/12 = 60
**years = 20*2 =40
d.
Cost of preferred stock = (100*0.07 ) / 85
= 7 /85
= 8.24%
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