Question

​(Individual or component costs of​ capital) Compute the cost of capital for the firm for the​ following: a. A bond that has a ​$1 comma 000 par value​ (face value) and a contract or coupon interest rate of 11.4 percent. Interest payments are ​$57.00 and are paid semiannually. The bonds have a current market value of ​$1 comma 120 and will mature in 10 years. The​ firm's marginal tax rate is 34 percet. b. A new common stock issue that paid a ​$1.82 dividend last year. The​ firm's dividends are expected to continue to grow at 6.5 percent per​ year, forever. The price of the​ firm's common stock is now ​$27.22. c. A preferred stock that sells for ​$142​, pays a dividend of 8.8 ​percent, and has a​ $100 par value. d. A bond selling to yield 11.9 percent where the​ firm's tax rate is 34 percent.

Answer 1

Answer:

The requirement is to calculate the cost of each finance instrument whose details were given in the question:

after tax cost of debt is 6.28%

cost of equity is 13.63%

cost of preferred stock is 6.20%

after tax cost of debt is 7.85%

Explanation:

1. after cost of debt:

The pretax cost of debt can be determined using the rate formula in excel:

=rate(nper,pmt,-pv,fv)

nper is the number of coupon payments the bond would make i.e 10*2=20

pmt is given as $57

pv is the current price of the bond $1120

fv is the par value of $1000

=rate(20,57,-1120,1000)=4.76%(semi-annually)

=9.52% annually

After cost of debt =9.52%*(1-0.34)=6.28%

2. cost of equity

share price=Do*(1+g)/r-g

r is the cost of equity

r=Do*(1+g)/share price+g

r=$1.82*(1+6.5%)/$27.22+6.5%

r=(1.94/27.22)+6.5%=13.63%

3. cost of preferred  share=dividend/market price

dividend=8.8%*$100=$8.8

market price is $142

cost of preferred share=$8.8/$142=6.20%

4.after tax cost of debt

pretax cost of debt is 11.9%

tax rate is 34%

after tax cost of debt =11.9%*(1-0.34)=7.85%