The Killington Corporation has planned capital expenditures of $40 million for t

Question

The Killington Corporation has planned capital expenditures of $40 million for the upcoming fiscal year. Killington's stock is currently selling at $22 per share. Flotation costs are 10%. The earnings growth rate has been steady and is expected to continue. The last dividend paid was $0.97 per share and is expected to grow at a rate of 9%. The company tax rate is 40%. The Mortgage bonds are currently selling for $1,073.61. The bonds are 7%, $1,000 par and pay interest annually. They will mature in 10 years.

Compute the after-tax cost of each component of capital.

a) Bonds

b) Retained Earnings

c) New Common Stock

Explanation / Answer

a)

b)

Cost of retained earnings, re = D1÷Price+Growth rate

= $0.97×(1+9%)÷$22+9%

= 13.81%

c)

Cost of new common stock, re = D1÷[Price×(1-F)]+Growth rate

= $0.97×(1+9%)÷[$22×(1-10%)]+9%

= 14.34%

Face value (FV) $                                  1,000.00 Coupon rate 7.00% Number of compounding periods per year 1 Interest per period (PMT)                                            70.00 Bond price (PV) $                               (1,073.61) Number of years to maturity 10 Number of compounding periods till maturity (N) 10 Bond Yield to maturity RATE(NPER,PMT,PV,FV) Bond Yield to maturity 6.00% (Pre-tax cost of debt) Bond Yield to maturity 3.60% (After-tax cost of debt) 6%*(1-40%)

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