The Killington Corporation has planned capital expenditures of $40 million for t

Question

The Killington Corporation has planned capital expenditures of $40 million for the upcoming fiscal year.
Killington's stock is currently selling at $22 per share. Flotation costs are 10%. The earnings growth rate
has been steady and is expected to continue. The last dividend paid was $0.97 per share and is expected
to grow at a rate of 9%. The company tax rate is 40%. The Mortgage bonds are currently selling for
$1,073.61. The bonds are 7%, $1,000 par and pay interest annually. They will mature in 10 years.
ALL FORMULAS CAN BE FOUND IN CHAPTER 10 SLIDES OR WACC EXAMPLE
Compute the after-tax cost of each component of capital.
a) Bonds
b) Retained Earnings
c) New Common Stock

Explanation / Answer

c) Cost of new common stock = {Annual dividend * [1 + growth rate] / current market price * (1 - flotation costs)}   +    growth rate

ie 0.97 * ( 1 + 0.09 ) / 22 * (1 + 0.10) + 0.09 = 0.143399 = 14.33 % (after tax cost)

b) Cost of retained earnings = [ next year's annual dividend / current market price ] + growth rate

                                               = [(0.97 * 1.09) / 22 ] + 0.09

                                               = 0.13806 = 13.81%

a) Cost of bond = i = ?; current bond price = $ 1073.61; annual coupon rate = 7% of face value = 1000 = $ 70; n = 10 years

using PV of Bond formula , PV of the bond =PV of coupon payments + PV of face value at maturity

ie `1073.61 = 70 * [ 1 - ( 1 + i ) ^-10 / i ] + 1000 / (1 + i ) ^10

solving in an online calculator we get i = 6% ie pretax cost

Pretax cost of bond = 6%

After tax cost of bond = 0.06 ( 1 - 0.40) = 0.036 = 3.6%

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