the company has a beta of 0.80, the risk free rate is 3.0. and the market rat3 o
ID: 2754220 • Letter: T
Question
the company has a beta of 0.80, the risk free rate is 3.0. and the market rat3 of return is 11.5%. Last year's dividend was $2.35, the current stock price is 88.10, and dividends have been growing at a rate of 5.5% annually. The company pays a rate of 2.25% on its short term debt and 5.75% on its long term debt. The preferred stock dividend paid by the company each year is 1.850,000. The company's tax rate os 38%. Calculate the capital structure of the company. What is the after tax cost of accounts payable, short term and long term debt and preferred stock? What is the rate of returm for the stock that you would recommend be used for the stock of the company and why?
Explanation / Answer
Capital Structure of the company
Equity
Short term debt
Long term debt
Preferred Stock
After tax cost on:
Accounts payable = 2.35 (1 - 0.38) = $1.457
Short term debt = 2.25 (1-0.38) = 1.395%
Long term Debt = 5.75 (1 - 0.38) = 3.565%
Preferred stock = 1.85 (1 - 0.38) = $1.147
The Rate of Return that should be used is as follows:
The Required Rate of return = Risk free rate + Beta security (Market Rate - Risk free rate)
= 3 +0.8( 11.5 - 3)
= 9.8%
This rate should be used as it has considered market risk premium after being adjusted by beta.
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