Copyright

Compute the cost of capital for the firm for the following: a. A bond that has a $1,000 par...

Question:

Compute the cost of capital for the firm for the following:

a. A bond that has a $1,000 par value (Face value) and a contract or coupon interest rate of 10.3 percent. Interest payments are $51.50 and are paid semiannually. The bonds have a current market value of $1,129 and will mature in 10 years. The firm's marginal tax rate is 34 percent.

b. A new common stock issue that paid a $1.79 dividend last year. The firm's dividends are expected to continue to grow at 6.2 percent per year, forever. The price of the firm's common stock is now $27.22.

c. A preferred stock that sells for $130, pays a dividend of 8.7 percent, and has a $100 par value.

d. Bond selling to yield 12.8 percent where the firm's tax rate is 34 percent.

Cost of Capital:

The cost of capital is the returns firms have to offer investor in order to sell new securities to raise capital. If the firm issues new bonds, the cost of debt is the after-tax yield to maturity on the bond. If the firm issues new equity, the cost of equity is the required return on the stock.

Answer and Explanation:

a. We first use the following equation to find the pre-tax yield to maturity on the bond, denoted by R.

  • {eq}\sum_{t=1}^{20}{\frac{51.50}{(1 + R)^t}}...

See full answer below.

Become a Study.com member to unlock this answer! Create your account

View this answer

Learn more about this topic:

Financial Policy & the Cost of Capital

from Finance 101: Principles of Finance

Chapter 14 / Lesson 2
2.4K

Explore our homework questions and answer library