The treasurer of Riley Coal Co. is asked to compute the cost of fixed income sec
ID: 2773912 • Letter: T
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.)
b. Compute the aftertax cost of preferred stock. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
c. Based on the facts given above, is the treasurer correct?
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.)
b. Compute the aftertax cost of preferred stock. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
c. Based on the facts given above, is the treasurer correct?
Explanation / Answer
a)After tax cost of debt = Yield (1- tax)
= 11 ( 1 - .20)
= 11 * .80
= 8.80%
b)cost of preferred stock = dividend / (price -floatation cost)
= 6.40 / (60 - 6 )
= 6.40 / 54
= .1185 or 11.85%
**cost of preferred stock is not tax deductible
c),Yes the treasurer is correct ,The cost od debt is 3 % less than cost of preferred stock [11.85 - 8.80 = 3.05%]
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