The treasurer of Riley Coal Co. is asked to compute the cost of fixed income sec
ID: 2739000 • Letter: T
Question
The treasurer of Riley Coal Co. is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 1 percent less than that for preferred stock.
Debt can be issued at a yield of 14.4 percent, and the corporate tax rate is 35 percent. Preferred stock will be priced at $69 and pay a dividend of $6.50. The flotation cost on the preferred stock is $6.
a. Compute the aftertax cost of debt
b. Compute the aftertax cost of preferred stock.
c. Based on the facts given above, is the treasurer correct?
The treasurer of Riley Coal Co. is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 1 percent less than that for preferred stock.
Debt can be issued at a yield of 14.4 percent, and the corporate tax rate is 35 percent. Preferred stock will be priced at $69 and pay a dividend of $6.50. The flotation cost on the preferred stock is $6.
a. Compute the aftertax cost of debt
b. Compute the aftertax cost of preferred stock.
c. Based on the facts given above, is the treasurer correct?
Explanation / Answer
a. After tax cost of debt = pretax cost *(1-tax rate) = 14.4*(1-0.35) = 9.36%
b. After tax cost of preferred shares = Divided/ (Price- floatation cost) = 6.50/(69-6) = = 10.32%
(There is no tax shield for preferred stock)
c. No, the treasurer is incorrect. Sicne cost of debt is about .96% lower than preferred stock slightly less than the 1% minimum said by the treasurer
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.