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# Inquiry about Bonds and Stocks

Compute the cost of the following:

A. A bond is selling to yield 7 percent after flotation costs, but before adjusting for the marginal corporate tax rate of 34 percent. In other words, 7 percent is the rate that equates the net proceeds from the bond with the present value of the future cash flows (principle and interest).

B. A new common stock issue paid a \$1.05 dividend last year. The par value of the stock is \$2.00 and the earnings per share have grown at a rate of 4 percent per year. This growth rate is expected to continue into the foreseeable future. The company maintains a constant dividend-earnings ratio of 40 percent. The price of this stock is now \$30, but 9 percent flotation costs are anticipated.

C. A bond that has a \$ 1000 par value and a contract, or coupon, interest rate of 12 percent. A new issue would net the company 90 percent of the \$1,150 market value. The bonds mature in 15 years, the firm's average average tax rate is 30 percent, and its marginal tax rate is 34 percent.

D. A preferred stock paying a 6 percent dividend on a \$100 par value. If a new issue is offered, the company can expect to net \$85 per share.

E. Internal common equity when the current market price of the common stock is \$35.00. The expected dividend this coming year should be \$4.00, increasing thereafter at a 4 percent annual growth rate. The corporation's tax rate is 34 percent.

#### Solution Preview

A. The cost of the bond is the after tax yield. The yield is given as 7% and the tax rate is 34%.
After tax yield = Before tax yield X (1-tax rate) = 7% X (1-0.34) = 4.62%
The cost of the bond is 4.62%.

B. We use the constat growth model. Cost of common stock = D1/MP + g
-where D1 is the expected dividend
- MP is the market price
- g is the growth rate
The last dividend was \$1.05. The earnings and dividends will ...

#### Solution Summary

This solution provides a detailed, step by step response which clearly illustrates how to solve for each of these stock related problems. An Excel attachment file also accompanies this solution for part C., as it shows how to compute one of the necessary calculations using the RATE function in Excel.

\$2.19