Chapter 9 The Cost of Capital 389

Chapter 9 The Cost of Capital 389

Easy Pr*biems t-8

(e-1)

After-Tax Cost of Debt

p4 After-Tax Cost of

Debt

(e-3)

Cost of Preferred Stock

(e-4)

Cost of Preferred Stock with Flotation

Costs

(c’s Cost ofEquity: DCF

(e-6)

Cost of Equity: CAPM

t9_l wAcc

te-8) urncc

Intermediate Problems $-14

(s-e)

Bond Yield and After-Tax Cost of

Debt

(e-10)

Cost of Equity

Calculate the after-tax cost of debt under each of the following conditions:

3. r.1 of 139/0, tax rate of 0% b. r,1 of 13%, tax rate of 207o c. 16 of 137o, tax rate of 35%

LL Incorporated’s currently outstanding 1l7o coupotl bonds have a yieid t<-r maturitl’of BVo. LL believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 35%, what is LL’s after-tax cost of debt?

l)uggins Veterinary Supplies can issue perpetual preferred stock at a price of $-i0 a share

Iqith an annual dividend of $4.50 a share. Ignoring flotation costs, what is the company’s

cost of preferred stock, r*,,?

Burnwood Tech plans to issue some $60 par preferred stock with a 67o dividend. A similar

stock is selling on the market fcrr $70. Burnwood must pay fiotation costs of 57o of the

issue price. What is the cost of the preferred stock?

Surnmerdahl Resort’s common stock is currently trading at $36 a share. The stock is

expecred to pay a dividend of $3.00 a share at the end of the year (Dr = $3.00), and the

dividend is expected to grow at a constant rate of 5o/o a year. What is its cost of common

equity?

Booher Book Stores has a beta of 0.8. The yield on a 3-rnonth T-bill is 4o/o, and the yield

on a 10-year T-bond is 6%. The market risk premium is 5.5%, and the return on an

average stock in the rnarket last year was l5%. What is the estimated cost of common

equity using the CAPM?

Shi Impofiers’s balance sheet shows $300 million in debt, $50 million in preferred stock, and

$250 million in total common equity. Shi’s tax rate is 407o, ta= 60/o, rr.. = 5.8%, and r” = 1270. If Shi has a target capital structure of 30% debt, 5% preferred stock, and 6570 common stock, what is its WACC?

David Ortiz Motors has a target capital structure of 40% debt and 60% equtty. The yield to

maturitv on the cornpany’s outstanding bonds ls 9%’ and the companlr’s tax rate is 407o’

Ortiz’s CFO has calculated the company’s WACC as9.960,/o. What is tl’re company’s cost of

equif capitai?

A company’s 6% coupon rate, semiannual palnrrent, $1,000 par value hond that matures in 30 years sells at a price of 5515.16. The company’s federal-plus-state tax rate is 40%’ What is the tirm’s after-tax conlponent cost of debt for purposes of calculating the

WACC? (Hint:Base your answer on the nominal rate.)

The earnings, dividends, and stock price of Shelby Inc. are expected to grow al 7o/a per

year in the future. Shelb,v’s common stock sells for $23 per share, its last dividend rvas

$2.00, and the company will pay a dividend of 1i2.14 at the end of the current year.

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

b. If the finn’s beta is 1.6, the risk-free rate is 9%, and the expected return on the mar-ket is 13%, then what would be the firm’s cost of equity based on the CAPM approach?