problems on ‘Cost of capital’

Problem Set on the Cost of Capital

1. Thatcher Corporation’s bonds will mature in 10 years. The bonds have a face value of $1,000 and an 8 percent coupon rate, paid semiannually. The price of the bond is $1,100. What is the firm’s cost (percentage rate) of borrowing money under these market conditions?

2. Bruner Aeronautics has preferred stock outstanding with a par value of $100. The stock pays a quarterly dividend of $2 and has a current price of $80. What will be Bruner’s cost of funds if the company decided to issue new preferred stocks?

3. Javits & Sons’ common stock is currently trading at $30 a share. The stock is expected to pay a dividend of $3.00 a share at the end of the year (D₁=$3.00), and the dividend is expected to grow at a constant rate of 5 percent a year. If the company were to issue external equity, it would incur a 10 percent flotation cost. What are the costs of internal and external equity?

4. The Heuser Company’s currently outstanding 10 percent coupon bonds have a yield to maturity of 12 percent. Heuser believes it could issue at par new bonds that would provide a similar yield to maturity. If its marginal tax rate is 35 percent, what is Heuser’s after-tax cost of debt?

5. Trivoli Industries plans to issue some $100 par preferred stock with an 11 percent dividend. The stock is selling on the market for $97.00, but Trivoli must pay flotation costs of 5 percent of the market price, so the net price the firm will receive is $92.15 per share. What is Trivoli’s cost of preferred stock with flotation considered?

6. The earnings, dividends, and stock price of Carpetto Technologies Inc. are expected to grow at 7 percent per year in the future. Carpetto’s common stock sells for $23 per share, its last dividend was $2.00, and the company will pay a dividend of $2.14 at the end of the current year.

a. Using the discounted cash flow approach, what is its cost of common equity?

b. If the firm’s beta is 1.6, the risk-free rate is 9 percent, and the average return on the market is 13 percent, what will be the firm’s cost of common equity using the CAPM approach?

c. If the firm’s bonds earn a return of 12 percent, what will be the firm’s cost of common equity using the own-bond-yield-plus-risk-premium? (Use a risk premium of 4%.)

d. On the basis of the results obtained in parts a through c, what would you estimate Carpetto’s cost of common equity to be?