The firm\'s tax rate is 40%. The current price of Harry Davis’s 12% coupon, semi

Question

The firm's tax rate is 40%. The current price of Harry Davis’s 12% coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity is $1,153.72. Harry Davis does not use short-term interest-bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost. The current price of the firm’s 10%, $100 par value, quarterly dividend, perpetual preferred stock is $116.95. Harry Davis would incur flotation costs equal to 5% of the proceeds on a new issue. Harry Davis’s common stock is currently selling at $50 per share. Its last dividend (D0) was $3.12, and dividends are expected to grow at a constant rate of 5.8% in the foreseeable future. Harry Davis’s beta is 1.2; the yield on T-bonds is 5.6%; and the market risk premium is estimated to be 6%. For the over-own-bond-yield-plus- judgmental-risk-premium approach, the firm uses a 3.2% judgmental risk premium Capital Structure Before-Tax Cost After-Tax Cost Component Cost Debt 30.00% Preferred 10.00% Common 60.00% WACC The firm's tax rate is 40%. The current price of Harry Davis’s 12% coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity is $1,153.72. Harry Davis does not use short-term interest-bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost. The current price of the firm’s 10%, $100 par value, quarterly dividend, perpetual preferred stock is $116.95. Harry Davis would incur flotation costs equal to 5% of the proceeds on a new issue. Harry Davis’s common stock is currently selling at $50 per share. Its last dividend (D0) was $3.12, and dividends are expected to grow at a constant rate of 5.8% in the foreseeable future. Harry Davis’s beta is 1.2; the yield on T-bonds is 5.6%; and the market risk premium is estimated to be 6%. For the over-own-bond-yield-plus- judgmental-risk-premium approach, the firm uses a 3.2% judgmental risk premium Capital Structure Before-Tax Cost After-Tax Cost Component Cost Debt 30.00% Preferred 10.00% Common 60.00% WACC

Explanation / Answer

The firm's tax rate is 40%. The current price of Harry Davis’s 12% coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity is $1,153.72. Harry Davis does not use short-term interest-bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost. The current price of the firm’s 10%, $100 par value, quarterly dividend, perpetual preferred stock is $116.95. Harry Davis would incur flotation costs equal to 5% of the proceeds on a new issue. Harry Davis’s common stock is currently selling at $50 per share. Its last dividend (D0) was $3.12, and dividends are expected to grow at a constant rate of 5.8% in the foreseeable future. Harry Davis’s beta is 1.2; the yield on T-bonds is 5.6%; and the market risk premium is estimated to be 6%. For the over-own-bond-yield-plus- judgmental-risk-premium approach, the firm uses a 3.2% judgmental risk premium Capital Structure Before-Tax Cost After-Tax Cost Component Cost Debt 30.00% 10.00% 6.00% 1.80% Preferred 10.00% 9.00% 9.00% 0.90% Common 60.00% 12.80% 12.80% 7.68% WACC WACC 10.38% Cost of debt Coupon Rate semiannually =12%/2 6% Face Value (FV) $1,000 PMT $60 Present Value (PV) $1,153.72 Nper = 15 x 2 30 periods Rate 5.00% Cost of debt before tax (calculated using Rate Function) 2 x 5% 10.00% After tax = 10% x(1-40%) 6.00% Cost of preferred Stock Dividend = 10% x $100 $10.00 Current price of stock - floatation cost ($116.95 x(1-5%) 111.1 Cost of preferred Stock = $10/$111.1025 9.00% Cost of Equity Cost of equiy = DO x(1+ g)/PO + g; $3.12 x(1+ 5.8%)/$50 + 5.8% 12.40% Cost of Equity = Rf + Beta x MRP; (5.6% + 1.2 x 6%) 12.80% Bond-yield-plusj udgmental-risk-premium approach, Cost of Equity =Cost of debt + market risk premium; 10% + 3.2% 13.20% Average cost of equity = (12.40% + 12.80% + 13.20%)/3 12.80%

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