Question

Bad Boys, Inc. is evaluating its cost of capital. Under consultation, Bad Boys, Inc. expects to issue new debt at par with a coupon rate of 8% and to issue new preferred stock with a $2.50 per share dividend at $25 a share. The common stock of Bad Boys, Inc. is currently selling for $20.00 a share. Bad Boys, Inc. expects to pay a dividend of $1.50 per share next year. An equity analyst foresees a growth in dividends at a rate of 5% per year. The Bad Boys, Inc. marginal tax rate is 35%. If Bad Boys, Inc. raises capital using 45% debt, 5% preferred stock, and 50% common stock, what is Bad Boys, Inc.’s cost of capital?

Answer 1

Answer:

Ans. Bad Boys, Inc.’s cost of capital = 9.09%

Explanation:

hi, we need to find the cost of all the debt instruments of the problem, let´s start by stating that the cost of hte tax-deductable debt is 8% (equals to the coupon rate of the bond).

Preffered Stock

In order to find the cost of the preffered stock, we need to use the following formula.

$Cost P.Stock =\frac{Dividend}{Price} =\frac{2.5}{25}=0.1$

Cost of Preffered Stock= 10%

Common Stock

To find the cost of the common stocks, we have to use the following formula.

$CommonStock=\frac{Div1+Price*GrowthRate}{Price}$

$CommonStock=\frac{1.5+20*0.05}{20} =0.125$

Common Stock Cost = 12.5%

If tax rate is 35%, the cost of capital of Bad Boys, Inc is found by using the following formula.

$CostCapital=Bond(CostBond)(1-T)+P.Stock(costP.Stock)+C.Stock(Cost.C.Stock)$

$CostCapital=0.45(0.08)(1-0.35)+0.05(0.1)+0.5(0.125)=0.0909$

The cost of capital is =9.09%

Best of luck.