# Calculating component costs of capital

1. Goodwill Corp. has a before-tax cost of debt of 11% and marginal tax rate of 37%. Compute the after tax cost of debt?

2. Goodwill Corp. issued preferred stock that has been paying annual dividends of $3.00 and the price of the preferred stock is $34 a share. Compute the cost of Robin's Nest Enterprises preferred stock:

3. Goodwill Corp. has a yearly common stock dividend at $3.25 a share. The stock is selling for $45 a share. The dividend is expected to grow at a rate of 7% per year. Compute the cost of common stock.

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#### Solution Preview

1. Goodwill Corp. has a before-tax cost of debt of 11% and marginal tax rate of 37%. Compute the after tax cost of debt?

After tax cost of debt = before tax cost X (1-tax rate)

After tax cost of debt = 11% X (1-0.37) = 6.93%

2. Goodwill Corp. issued ...

#### Solution Summary

The solution explains how to calculate the cost of debt, cost of preferred stock and cost of common stock

Cost of Capital: Cost of components of capital

INPUTS USED IN THE MODEL

P0 $50.00

Net Ppf $30.00

Dpf $3.30

D0 $2.10

g 7%

B-T kd 10%

Skye's beta 0.83

Market risk premium, MRP 6.0%

Risk free rate, kRF 6.5%

Target capital structure from debt 45%

Target capital structure from preferred stock 5%

Target capital structure from common stock 50%

Tax rate 35%

Flotation cost for common 10%

a. Calculate the cost of each capital component, i.e., the after-tax cost of debt, the cost of preferred stock (including flotation costs), the cost of equity (ignoring flotation costs) with the DCF method and the CAPM method.

b. Calculate the cost of new stock using the DCF model.

c. What is the cost of new common stock, based on the CAPM? (Hint: Find the difference between ke and ks as determined by the DCF method, and add that differential to the CAPM value for ks.

See attached file for full problem description.

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