Crypton Electronics has a capital structure consisting of 40% common stock and 6

Question

Crypton Electronics has a capital structure consisting of 40% common stock and 60% debt. A debt issue of $1,000 par value, 6.4% bonds that mature in 15 years and pay annual interest will sell for $978. Common stock of the firm is currently selling for $30.38 per share and the firm expects to pay a $2.21 dividend next year. Dividends have grown at the rate of 5.1% per year and are expected to continue to do so for the foreseeable future. What is Crypton's cost of capital where the firm's tax rate is 30%? (ROUND TO THREE DECIMAL PLACES) Crypton's cost of capital is _______%

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Step 1: Calculate Cost of Debt:

FV = 1000 (indicates the face value of bonds)

PV = 978 (indicates the present value of bonds)

PMT = 1000*6.4% = 64 (indicates annual interest payment)

Nper = 15 (indicates the period)

Rate = ? (indicates the cost of debt)

After Tax Cost of Debt = Rate(Nper,PMT,PV,FV)*(1-Tax Rate) = Rate(15,64,-978,1000)*(1-30%) = 4.645%

Part B:

Cost of Equity = D1/Current Market Price + Growth Rate = 2.21/30.38 + .051 = 12.375%

Part C:

Cost of Capital = After Tax Cost of Debt*Weight of Debt + Cost of Equity*Weight of Equity = 4.645*60% + 12.375*40% = 7.737%

Thanks.

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