ABC would like to expand and have a capital structure of: 10 million preferred s

Question

ABC would like to expand and have a capital structure of: 10 million preferred stock 30 million debt 60 million common equity ABC would like to expand, in order to do so they must issue new debt with a 12% coupon rate, $1,000 par value, that have 15 year maturities. The floatation costs are 2% per bond. Preferred stock will cost ABC 11% after taxes. ABC's common stock currently sells for $22 a share and next year will pay a quarterly dividend of $0.25 per share. If the stock dividends are expected to continue to grow at a rate of 4% per year for the foreseeable future. ABC's tax rate is 35%. Find the marginal cost of debt.

Explanation / Answer

Net proceeds=1000-2%*1000=980

Coupon=12%*1000=120

Par value=1000

Maturity=15 years

Pre-tax cost of debt=12.30%....Use RATE(15,120,-980,1000) function in excel

After-tax cost of debt=pre-tax cost of debt * (1- tax rate)=12.30*(1-0.35)=7.995%

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