Cost of Capital

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Submitted By walkingtree101
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1. If a corporation has an average tax rate of 40 percent, what is the approximate, annual, after-tax cost of debt for a 15-year, 12 percent, $1,000 par value bond, selling at $950? Flotation costs are 1% of face value. The interest payments are semi-annual.

PV = 950 – (1000*.01) = 940, FV = -1000, PMT = 120/2 = -60, N = 15 x 2 = 30, I = ? Before tax cost of debt = 6.46 x 2 = 12.92%
After-tax cost of debt = 12.92(1-.4) = 7.75%

2. A firm has issued 10 percent preferred stock, which sold for $100 per share par value. The cost of issuing and selling the stock was $2 per share. The firm's marginal tax rate is 40 percent. What is the cost of the preferred stock?

Cost of preferred = 10/(100-2) = 10.2%

3. A firm has a beta of 1.2. The market return equals 14 percent and the risk-free rate of return equals 6 percent. What is the estimated cost of common stock equity (retained earnings)?

Cost of RE = 6 + (14-6)1.2 = 15.6%

4. A firm has determined its optimal capital structure which is composed of the following sources and target market value proportions.

Debt: The firm can sell a 12-year, $1,000 par value, 7 percent bond for $960. A flotation cost of
2 percent of the face value would be required in addition to the discount of $40. The coupon payment is semi-annual. Additionally, the firm's marginal tax rate is 40 percent.
Preferred Stock: The firm has determined it can issue preferred stock at $75 per share par value. The stock will pay a $10 annual dividend. The cost of issuing and selling the stock is $3 per share.
Common Stock: A firm's common stock is currently selling for $18 per share. The dividend expected to be paid at the end of the coming year is $1.74. Its dividend payments have been growing at a constant rate of 4% for the last four years. It is expected that in order to sell, a new common stock issue must be underpriced $1…...

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