University of the West Indies

Department of Management Studies

MS28D Financial Management I

Tutorial #8 - Cost of Capital - Chapter 9

    

  1. 9-1

  2. 9-2

  3. 9-3

  4. Compute the cost for the following sources of financing:

 a.          A bond that has a $1,000 par value and a coupon interest rate of 11%. A new issue would have a floatation costs of 5% of its$1,125 market value. The bond matures in 10 years. The firm’s tax rate is 34%.

 b.         A preferred stock paying a 9% dividend on a $150 par value. If the new issue is offered, floatation cost will be 12% of the current price of $175.

c.          Internal common equity where the current market price of the common stock is $43. The expected dividend this coming year should be $3.50, increasing there after at a 7% annual growth rate. The corporate tax rate is 34%.

d.         A new issue of common stock that paid dividend last year of $1.80. The par value of the stock is $15, and earnings per share have a growth rate of 7% per year. This growth is expected to continue into the foreseeable future. The company maintains a constant dividend / earnings ratio of 30%. The price of this stock is now $27.50, but selling costs will be 5% of this price.

  1. Salt Corp. is issuing new common stock at a market price of $27. Dividends last year was $1.45 and is expected to grow at an annual rate of 6% forever. Floatation costs will be 6% of the market price. What is Salt's after tax cost of equity, if the corporation tax rate is 34%?

  2. The preferred stock of Water Industries sells for $36 and pays $2.50 in dividends. The net price of the security after issuance costs is $32.50. What is the cost of capital for the preferred stock, if Water’s tax rate is 34%?  

  3. 9-6

  4. Your firm is planning to issue preferred stock. The stock sells for $115; however, if new stock were issued, the company would receive only $98. The par value of the stock is $100 and the dividend rate is 14%. What is the cost of capital of this stock?  

  5. Belton is issuing a $1,000 par value bond that pays 7% annual interest and matures in 15 years. Investors are willing to pay $958 for this bond. Floatation costs will be 11% of the market value. The company is in an 18% tax bracket. What will be the firm’s after-tax cost of debt on this bond?  

  6. The Wallblack Corp. is contemplating a new investment, 33% of it to be financed using debt. The firm could sell new $1,000 par value bonds at a net price of $950. The coupon interest rate is 13%, and the bonds will mature in 15 years. If the company is in a 34% tax bracket, what is the after-tax cost of capital for Wallblack’s bonds?

  7. The common stock of Panto Ltd. is currently selling for $21.50. Dividends paid last year were $0.70. Floatation costs on issuing stock will be 10% of market price. The dividends and earnings per share are projected to have an annual growth rate of 15%. What is the cost of internal common equity for Panto?

  8. 9-7

  9. The common stock For Brands Corp. sells for $60. If a new issue is sold, the floatation costs ~re estimated to be 9% of the market price. The company pays 50% of its earnings in dividends, and a $4.50 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 35%. Calculate the cost of:

 a.         internal common equity and

b.         external common equity

  1. 9-17

  2. The capital structure of Camel Corp. contains $1,083,000 of debt, $268,000 of preferred stock and $3,681,000 of common equity. The company plans to maintain this financing mix in the future. If the firm has a 5.5% cost of debt, a 13.5% cost of preferred stock, and an 18% cost of common equity, what is the firm’s weighted cost of capital?  

  3. The Sun Co. has a capital structure containing debt, preferred stock and common equity in the proportion of 30%, 15% and 55% respectively. Assuming that management intends to maintain this financial structure, what amount of total investment may be financed if the firm restricts its common equity financing to $200,000 that is available from internally generated funds.

  1. 9-9

  2. 9-10

  3. Calvert Inc. is planning to issue new securities but would incur floatation costs as follows:

             (i)            15% of market value for bonds

            (II)            $2.01 per share for preferred stock and

(iii) $1.21 per share for common stock.

Market prices are $1,035 for bonds, $19 for preferred stock and $35 for common stock. There will be $500,000 of internal common equity available. The dividends for common stock were $2.50 last year and are projected to have a constant annual growth rate of 6%. The firm is in a 34% tax bracket.

What is the weighted cost of capital if the firm finances in the proportions shown below?

 Type of Financing   Percentage of Total Financing
8% Bonds ($1,000 par, 16-year maturity)   38%
 3% Preferred Equity ($50 par) 15%
Common Equity   47

  1. 9-19

  2. 9-20