(12 points) Compute the costs for the following sources of financing: a. A $1,00

Question

(12 points) Compute the costs for the following sources of financing: a. A $1,000par value bond with a market price of $970 and a coupon interest rate of 10 1. percent. Flotation costs for a new issue would be approximately 6 percent of market price. The bond matures in 8 years, and the marginal corporate tax rate is 35 percent b. A preferred stock selling for $100 with an annual dividend payment of $8. The flotation cost will be $10 per share. The company's marginal tax rate is 30 percent. c. Retained earnings total S4.8 million. The price of the common stock is $75 per share, and dividend per share was $9.8 last year. The dividend is not expected to change in the future. d. New common stock for which the most recent dividend was $3.2. The company's dividends per share should continue to increase at a 9 percent growth into the indefinite future. The market price of the stock is currently $60; however, flotation costs of $6 per share are expected if the new stock is issued.

Explanation / Answer

Solution:

a. Given that Face value, F = 1000, Price, P = $970 (1 – 0.06) = 911.8, number of years, n = 8, coupon rate, I = 0.10*1000 = 100

Using YTM approximation formula, we have

YTM = [I + (F – P)/n] / (F + P)/2

YTM = [100 + (1000 – 911.8)/8]/ (1000 + 911.8)/2

YTM = 11.76%

After-tax cost of debt = YTM*(1 – tax rate)

After-tax cost of debt = 11.76%*(1 – 0.35) = 7.644%

b. Cost of preferred stock, kp

kp = Dp/Np

kp = $8/($100 - $10)

kp = 8.89%

c. Cost of retained earnings, ke

ke = D1/P0 + g

ke = $9.8/75 + 0

ke = 13.07%

d. Cost of common stock, ks

ks = D1/P0 + g

ks = $3.2/($60 - $6) + 0.09

ks = 14.93%  

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