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# Principles of Finance - The Cost of Capital

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1) (Cost of Debt) Belton is issuing a \$1,000 par value bond that pays 7 percent annual interest and matures in 15 years. Investors are willing to pay \$958 for the bond. Flotation costs will be 11 percent of market value. The company is in an 18 percent tax bracket. What will be the firm's after-tax cost of debt on the bond?

2) (Cost of Preferred Stock) The preferred stock of Julian Industries sells for \$36 and pays \$3.00 in dividends. The net price of the security after issuance costs is \$32.50. What is the cost of capital for the preferred stock?

3) (Cost of Debt) The Zephyr Corporation is contemplating a new investment to be financed 33 percent from debt. The firm could sell new \$1,000 par value bonds at a net price of \$945. The coupon interest rate is 12 percent, and the bonds would mature in 15 years. If the company is in a 34-percent tax bracket, what is the after-tax cost of capital to Zephyr for bonds?

4) (Cost of Preferred Stock) Your firm is planning to issue preferred stock. The stock sells for \$115; however, if new stock is issued, the company would receive only \$98. The par value of the stock is \$100, and the dividend rate is 14 percent. What is the cost of capital for the stock to your firm?

5) (Cost of Internal Equity) Pathos Co.'s common stock is currently selling for \$23.80. Dividends paid last year were \$0.70. Flotation costs on issuing stock will be 10 percent of market price. The dividends and earnings per share are projected to have an annual growth rate of 15 percent. What is the cost of internal common equity for Pathos?

6) (Cost of Equity) The common stock for the Bestsold Corporation sells for \$58. If a new issue is sold, the flotation costs are estimated to be 8 percent. The company pays 50 percent of its earnings in dividends, and a \$4 dividend was recently paid. Earnings per share 5 years ago were \$5. Earnings are expected to continue to grow at the same annual rate in the future as during the past 5 years. The firm's marginal tax rate is 34 percent. Calculate the cost of (a) internal common equity and (b) external common equity.

7) (Cost of Debt) Sincere Stationary Corporation needs to raise \$500,000 to improve its manufacturing plant. It has decided to issue a \$1,000 par value bond with a 14 percent annual coupon rate and a 10-year maturity. The investors require a 9 percent rate of return.
a. Compute the market value of bonds.
b. What will the net price be if flotation costs are 10.5 percent of the market price?
c. How many bonds will the firm have to issue to receive the needed funds?
d. What is the firm's after-tax cost of debt if its average tax rate is 25 percent and its marginal tax rate is 34 percent?

8) (Cost of Debt)
a. Rework problem 7 as follows: Assume an 8 percent coupon rate.

#### Solution Preview

Please see the attached Excel file for the full breakdown of the solutions.

1) (Cost of Debt) The firm's after-tax cost of debt on the bond is 7.22%.
2) (Cost of Preferred Stock) The cost of capital for the preferred stock is 9.23%.
3) (Cost of Debt) The ...

#### Solution Summary

Solution helps in computing after-tax cost of debt on the bond , Cost of Preferred Stock, equity & Debt.

\$2.19