Your firm is considering a new investment proposal and would like to calculate i

Question

Your firm is considering a new investment proposal and would like to calculate its weighted average cost of capital. To help in this, compute the cost of capital for the firm for the following:

a.A bond that has a $1,000 par value (face value) and a contract or coupon interest rate of 11.9 percent that is paid semiannually. The bond is currently setting for a price of $1,129 and will mature in 10 years. The firm's tax rate is 34 percent. If the firm's bonds are not frequently traded, how would you go about determining a cost of debt for this company?.

b.A new common stock issue that paid a $1.74 dividend last year. The par value of the stock is $16, and the firm's dividends per share have grown at a rate of 8.7 percent per year. This growth rate is expected to continue into the foreseeable future. The price of this stock is now $27.88..

c.A preferred stock paying a 9.3 percent dividend on a $120 par value. The preferred shares are currently setting for $153.18..

d.A bond setting to yield 13.9 percent for the purchaser of the bond. The borrowing firm faces a tax rate of 34 percent

Explanation / Answer

a. Cost of debt = Interest rate (1 - tax)

= 11.90% (1-0.34)

= 7.85%

b. Ke (cost of equity) = [Do(1+g)/P0] + g

= [1.74(1+0.087)/27.88]+ 0.087

= 15.48%

c. Cost of prfferred stock = 120 x 9.30%/153.18

= 7.29%

d. Cost of debt = 13.90%(1-0.34)

= 9.17%

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