# Calculating after tax cost of capital

1.The Millennium Charitable Foundation, which is tax-exempt, issued debt last year at 8 percent to help finance a new playground facility in Chicago. This year the cost of debt is 15 percent higher; that is, firms that paid 10 percent for debt last year would be paying 11.5 percent this year.

A. If the Millennium Charitable Foundation borrowed money this year, what would the after tax cost of the debt be, based on its cost last year and the 15 percent increase?

B. If the foundation was found to be taxable by the IRS (at a rate of 35 percent) because it was involved in political activities, what would the after tax cost of the debt be?

2. Mary Ott Hotels wants to determine the minimum cost of capital point for the firm. Assume it is considering the following financial plans:

Cost (after tax) Weights

Plan A

Debt..................... 6.0% 20%

Preferred stock......... 10.0 10

Common equity............ 13.0 70

Plan B.

Debt.......................... 6.5% 30%

Preferred stock............. 10.5 10

Common equity............ 13.5 60

Plan C.

Debt........................ 7.0% 40%

Preferred stock............ 10.7 10

Common equity.......... 14.2 50

Plan D.

Debt........................ 9.0% 50%

Preferred stock............ 11.2 10

Common equity.......... 16.0 40

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#### Solution Preview

1. The Millennium Charitable Foundation, which is tax-exempt, issued debt last year at 8 percent to help finance a new playground facility in Chicago. This year the cost of debt is 15 percent higher; that is, firms that paid 10 percent for debt last year would be paying 11.5 percent this year.

A. If the Millennium Charitable Foundation borrowed money this year, what would the after tax cost of the debt be, based on its cost last year and the 15 percent increase?

Since this foundation is tax exempt, after tax cost of debt will be same as pretax cost of debt.

After tax cost of debt =8%*(1+15%)=9.20%

B. If the foundation was found to be taxable by the IRS (at a rate of 35 percent) because it was involved in political ...

#### Solution Summary

Solution describes the steps to calculate after tax debt and capital.

Calculating cost of capital

An analyst is attempting to determine the weighted average cost of capital for Coleslaw, Inc. The analyst has determined that Coleslaw has 3,000,000 shares of common stock outstanding, priced at $32 per share. The stock's beta is 0.90. The analyst expects that shares will pay a dividend of $2.00 next year, and that dividends will grow at 6.00%.

The company faces a tax rate of 40%. The risk less rate is 3%, and the analyst believes the expected return on the stock market is 11%.

The company has issued 325,000 shares of preferred stock, with a par value of $105.00, paying a dividend of $6.30. The preferred shares are currently selling at $98.00 each.

The company has two outstanding bond issues. The first is a 10-year zero coupon bond with a face value of $42,000,000, currently priced at $20,378,145. The second bond issue matures in 5 years, has a 5.50% coupon rate, an $80,000,000 face value, and a yield to maturity of 6.25%.

Questions.

1. Based on CAPM, what is the after-tax cost of common equity for Coleslaw, Inc.?

2. Based on the constant-growth dividend discount model, what is the after-tax cost of common equity for Coleslaw, Inc.?

3. What is the after-tax cost of preferred equity for Coleslaw, Inc.?

4. What is the after-tax cost of Coleslaw's zero coupon debt?

5. What is the after-tax cost of Coleslaw's 5-year bond?

6. What is the total dollar amount of Coleslaw's capital?

7. What is the weight of common equity in Coleslaw's capital structure?

8. What is Coleslaw's weighted average cost of capital (WACC), using the CAPM-based cost of common equity?