(Individual or component costs of capital) 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%. The bonds have a current market value of $1,126 and will mature in 10 years. The firm's marginal tax rate is 34%.
The cost of capital from this bond is ___%. (round to two decimal places).

b. A new common stock issue that paid a $1.82 dividend last year. The firm's dividends are expected to continue to grow at 7.1% per year forever. The price of the firm's common stock is now $27.67.
The cost of capital from this bond is ___%. (round to two decimal places).

c. A preferred stock paying a 8.9% dividend on a $143 par value.
The cost of capital from this bond is ___%. (round to two decimal places).

d. A bond selling to yield 12.1% where the firm's tax rate is 34%.
The cost of capital from this bond is ___%. (round to two decimal places).

Solution Preview

Dear Student:

Qa. Using a financial calculator, input the numbers. I have done the calculations with an HP 10BII. If you have another calculator, you may need to adjust accordingly.

N = 10 (years)
PV = -1126 (input present value as a negative number)
PMT = 119 (in dollars, 11.9% of 1000 face value = .119 * 1000 = $119)
FV = 1000 (future value is the face value)
Solve for I = 9.8615853% (unrounded; yield to maturity)
Compute the after-tax cost of debt = (1 ? tax rate)*(before-tax cost of debt) = (1 ? 0.34)* 9.8615853% = 6.508646 = 6.51%

Question1
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Question2
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Scenario Probability Stocks Bonds
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Normal Economy 0.60 15% 8%
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Pretax weighted a