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Cost of Equity and Debt for HD Industries

HD Industries data is as follows:

- The firm's tax rate is 40%
- The current price of HD's 12% coupon, semiannual payment, noncallable bonds wit 15 years remaining to maturity is $1,153.72. HD does not use short term interest bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost.
- The current price of the firm's 10%, $100 par value, quarterly dividend, perpetual preferred stock is $116.95. HD would incur flotation costs equal to 5% of the proceeds on a new issue.
- HD's common stock is currently selling at $50 per share. Its last dividend (Do) was $4.19, and the dividends are expected to grow at a constant rate of 5% in the foreseeable future. HD's beta is 1.2, the yield on T-bond is 7%, and the market risk premium is estimated to be 6%. For the bond yield plus risk premium approach, the firm uses a 4 percentage point risk premium.
- HD's target capital structure is 30% long term debt, 10% preferred stock, and 60% common equity.

1. HD estimates that if it issues new common stock, the floatation cost will be 15%. HD incorporates the floatation costs into the DCF approach. What is the estimated cost of newly issued common stock, taking into account the floatation cost?

2) Suppose HD issues 30 year debt with a par value of $1000 and a coupon rate of 10%, paid annually. If flotation costs are 2%, what is the after tax rate cost of debt for the new bond issue?

Solution Summary

The solution explains how to determine the cost of debt and cost of equity with calculations and answers in an attached Excel file.