A firm can issue a 15-year, $1,000 par value bond with a 10% coupon rate, paying

Question

A firm can issue a 15-year, $1,000 par value bond with a 10% coupon rate, paying interest semiannually, at price of $862.35. Their marginal tax rate is 40%. A dividend of $1.25 was just paid on the firm's common stock, and the firm's estimated growth rate is 8%. It can issue new common stock at $25.00 1.2. with a 20% flotation cost. The Risk-free Return is 6%, the Market Return is 12%, and the firm's beta is 1. Calculate the firm's Cost of Debt, after-tax. 15yr bond N: 30 a (I-0.4) price oa. 35 PY--802.35 par 1ooo PMT 50 (.10l000 10o/a) f V: 10006 2. Calculate the firm's Cost of Retained Earnings using the CAPM. 3. Calculate the firm's Cost of new Common Stock.

Explanation / Answer

Yes, your calculation in question - 1 is 100% correct

Coupon [ 1 - (1+r)-30 ] + Maturity value (1+r)-30 = 862.35

We have find r in the above equation. When we substitute 12% ( i.e 0.06 being semi annual equivalent) above equation is satisfied. That means cost of debt = 12% (before tax) and

12( 1 - 0.40) = 7.20% after tax.

Question - 2

Using CAPM approach cost of retained earnings = required rate of return = Rf + Beta ( Rm - Rf)

= 6 + 1.2 ( 12 - 6) = 13.20%...................final answer

Question - 3

Cost of common stock ( new issue) = Expected dividend / Proceeds per share * 100 + growth rate

= 1.35 / 20 * 100 + 8 = 14.75 % ................final answer

Expected dividend = 1.25 ( 1.08) and Proceeds per share = 25 - 20% of 25

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