43. All else cons l. Increase in the yield to maturity of the firm\'s outstandin

Question

43. All else cons l. Increase in the yield to maturity of the firm's outstanding debt I1. Decrease in the yield to maturity of the firm's outstanding debt III. Increase in the firm's tax rate IV. Decrease in the firm's tax rate A. I only B. I and IIl only C. I and IV only D. II and III only E. II and IV only 44. Etude Cosmetics just paid its first annual dividend of S0.12 a share. The firm plans to increase the dividend by 3.5 percent per year indefinitely. What is the firm's cost of equity if the current stock price is $6.50 a share? A. 5.35 percen B. 5.41 percent C. 14.42 percent D. 18.79 percent E. 19.98 percent

Explanation / Answer

Solution: 43. Answer is C. I and IV only. Working Notes: After tax cost of debt of a firm = YTM x (1-tax rate) in above formula we can observe that YTM is main multiple , if YTM will increase . The overall after tax cost of debt of the firm will increase . Tax rate is decreasing the cost of debt , by giving tax benefits on interest, as tax will decreases the multiple to YTM will increases and after tax cost of debt of a firm will also increases as multiple factor to Ytm will increases with decrease in Tax rate 44. Answer is B. 5.41 percent Working Notes: Using Gordon growth model : P0 = D1 / (Ke - g), where D1 = D0(1+g) ke = cost of Equity =?? Po=current share price = $6.50 per share g= growth rate= 3.50% D0= Current Dividend=$0.12 per share P0 = D0(1+g)/(Ke -g) Ke=D0(1+g)/P0   + g Ke=0.12(1+0.035)/6.50   + 0.035 Ke=   0.019107692 + 0.035 Ke= 0.054107692 Ke=5.41% Please feel free to ask if anything about above solution in comment section of the question.

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