The treasurer of Riley Coal Co. is asked to compute the cost of fixed income sec

Question

The treasurer of Riley Coal Co. is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 3 percent less than that for preferred stock. Debt can be issued at a yield of 11.0 percent, and the corporate tax rate is 20 percent. Preferred stock will be priced at $60 and pay a dividend of $6.40. The flotation cost on the preferred stock is $6. a. Compute the aftertax cost of debt. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Aftertax cost of debt % b. Compute the aftertax cost of preferred stock. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Aftertax cost of preferred stock %

Explanation / Answer

After tax cost of debt = Bond yield×(1-20%)

= 11%×(1-20%)

= 8.80%

After tax Cost of preferred stock = Preferred dividend/(Stock price-Flotation costs)

= $6.40/($60-$6)

= 11.85%

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