Chapter 14 The Cost of Capital Question 1: Compute the cost of capital for the f
ID: 2816104 • Letter: C
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Chapter 14 The Cost of Capital Question 1: Compute the cost of capital for the firm for the following A bond that has a $1,000 par value (face value). And a contract or coupon interest rate of 1 1%. Interest payments are $55 and are paid semiannually. The bonds have a current market value of S1,125 and will mature in 10 years. The firms' marginal tax rate is 34% A new common stock issue that paid a $1.80 dividend last year. The firm's dividends are expected to continue to grow at 7% per year, forever. The prince of the firm's common stock is now $27.50. A preferred stock that sells for $125, pays a 9% dividend, and has $100 pay value. A bond selling to yield 12% where the firm's tax rate is 34% a. b. c. d. Question 2: The target capital structure of a firm s 50% common stock, 15% preferred stock and 35% debt. If the cost of common equity for this firm is 20%, of preferred stock is 12% and the before-tax cost of debt is 10%. What is the firm's cost of capital, "The tax rate is 34%.Explanation / Answer
Question 1)
a)
Coupon payment = 0.11 * 1000 = 110 / 2 = 55
Number of periods = 10 * 2 = 20
Face value = $1,000
Price = $1,125
Before tax cost of debt using a financial calculator = 9.072%
Keys ot use in a financial calculator: 2nd I/Y 2, PV -1125, FV 1000, N 20, PMT 55, CPT /Y
After tax cost of debt = 0.09072 ( 1 - 0.34)
After tax cost of debt = 0.0599 or 5.99%
b)
Cost of common equity = ( D1 / stock price) + growth
Cost of common equity = [( 1.8 * 1.07) / 27.5 ] + 0.07
Cost of common equity = 0.07 + 0.07
Cost of common equity = 0.14 or 14%
c)
Annual dividend = 0.09 * 100 = 9
Cost of preferred stock = Annual dividend / Preferred stock price
Cost of preferred stock = 9 / 125
Cost of preferred stock = 0.072 or 7.2%
d)
Cost of debt = 0.12 ( 1 - 0.34)
Cost of debt = 0.0792 or 7.92%
Question 2)
Cost of capital = Weight of common stock * cost of common stock + weight of preferred stock * cost of preferred stock + weight of debt * cost of debt
Cost of capital = (0.5 * 0.2) + (0.15 * 0.12) + 0.35 * 0.1 * ( 1 - 0.34)
Cost of capital = 0.1 + 0.018 + 0.0231
Cost of capital = 0.1411 or 14.11%
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