a. A bond that has $1000 par value (face value) and a contract or coupon interes

Question

a. A bond that has $1000 par value (face value) and a contract or coupon interest rate of

7 percent. A new issue would have a floatation cost of 6percent of the

$1135 market value. The bonds mature in 12 years. The firm's average tax rate is 30 percent and its marginal tax rate is

37percent.

b. A new common stock issue that paid a $1.60 dividend last year. The par value of the stock is $15, and earnings per share have grown at a rate of 12 percent per year. This growth rate is expected to continue into the foreseeable future. The company maintains a constant dividend-earnings ratio of 30 percent. The price of this stock is now $28,but 7 percent flotation costs are anticipated.

c. Internal common equity when the current market price of the common stock is $47

.The expected dividend this coming year should be $3.00

, increasing thereafter at an annual growth rate of

11 percent. The corporation's tax rate is 37

percent.

d. A preferred stock paying a dividend of 12 percent on a $110 par value. If a new issue is offered, flotation costs will be

9 percent of the current price of $165

e. A bond selling to yield 15 percent after flotation costs, but before adjusting for the marginal corporate tax rate of

37 percent. In other words, 15 percent is the rate that equates the net proceeds from the bond with the present value of the future cash flows (principal and interest).

Explanation / Answer

As per rules, I am answering the first 4 sub parts of the given question

a.

Face value = $1000

Market value = $1135

Floatation cost = 6%

Hence PV = 1135*(1-6%) = 1066.9

Maturity = 12 years

Coupon rate = 7%

Hence coupon amount = 7%*1000 = $70

First we will compute the Yield on the bonds using the Rate function in excel as follows

= RATE(12,70,-1066.90, 1000)

YTM = 6.19%

Cost of debt = YTM * (1-Marginal tax rate)

= 6.19%*(1-37%)

= 3.90% (rounded off)

b.

D0 = $1.6

Net proceeds from stock = $28*(1- floatation cost) = $28*(1-7%) = $26.04

Growth = 12%

Hence D1= 1.6*(1+12%) = $1.79

Using the Dividend growth model,

Cost of equity = YearStock

= (1.79/26.04)+ 12%

Cost of equity = 18.87%

c.

Since there is no tax benefit on dividend distribution, the tax rate is irrelevant to this question.

Cost of equity = (Next Year's Annual Dividend / Current Stock Price) + Dividend Growth Rate

= (3/47) + 11%

=17.38%

d.

Preference dividend = 12%*110 = $13.2

Net proceeds = 165*(1-9%) = $150.15

Cost of preference dividend = 13.2/ 150.15 = 8.79%

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