2. The Killington Corporation has planned capital expenditures of $40 million fo

Question

2. 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.

            Compute the after-tax cost of each component of capital.

                        a) Bonds                                                                                   

                        b) Retained Earnings                                                                                       

                        c) New Common Stock                                                                                  

Explanation / Answer

a) 7% Bonds Let before-tax cost of debt = rd 1,073.61 = 110/(1+rd) + 110/(1+rd)^2 + 110/(1+rd)^3 ....1110/(1+rd)^10 rd = 9.22% before-tax cost of debt = 9.22%*(1-40%) =5.53% b)22*(1-10%)=0.97*1.1/(re-9%) re =15.56%

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