Question

A firm that is in the 35% tax bracket forecasts that it can retain $4 million of new earnings plans to raise new capital in the following proportions:

60% from 30-year bonds with a flotation cost of 4% of face value. Their current bonds are selling at a price of 91 (91% of face value), have 4 years remaining, have an annual coupon of 7%, and their investment bank thinks that new bonds will have a 40 basis point (0.40%) higher yield-to-maturity than their current 4-year bonds due to their longer term. Any new bonds will be sold at par.

10% from preferred stock with a flotation cost of 5% of face value. The firm currently has an outstanding issue of $30 face value fixed-rate preferred stock with an annual dividend of $2 per share, and the stock is currently selling at $27 per share. Any newly issued preferred stock will continue with the $30 par-value, and will continue with the $2 dividend.

30% from equity. Their common dividend payout ratio is 60%, they paid a dividend of $1.59 per share yesterday, the dividend is expected to grow to $4.22 in 20 years, and is expected to continue this growth rate into the foreseeable future. The common stock has a current market price of $19, and their investment banker suggests a flotation cost of 7% of market value on new common equity.

Part 1: Calculate the after-tax cost of the new bond financing. ___________

Part 2: Calculate the after-tax cost of the new preferred stock financing. ______

Part 3: Calculate the after-tax cost of retained earnings financing. _______

Part 4: Calculate the after-tax cost of the new common equity financing. ______

Answer 1

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Page Date Porfeded Stoon Cost Finuncing divident = 251 + Mayket vanie = 27 +2221$ Cost of I - Poefedence_ Divo 100 Ro 2 x bo 29 = [6.gode Sale b_cost of Fauty Divident 1.515 u ofter 20 years: I Divident 4.22 Youth Rate = ( 1.22 120 17.59 Ilse 105-1 toat 12:2. 0. 01 Mearns Sl. growth Raute- mau ket prices of_stocka_19% Ce02 20.33€ Divident, & Dingfita) = 1.676

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(d) cost of Eauity the = Dividenta Po 1.67 x 100+5 20.33 = 18,21% 7+5%. = 113.21.17 (2 cost of Retained Earninys: .- Retained Earninys #9 Po 1.113 t 95% 20.33 19 5.48% 75% = [10471.1 (Note: Reained earnings Div. x 20 -1.5gx yol 1.06

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