Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Solve the question (part d and e only) step-by-step with comprehensive explanation where required.
Transcribed Image Text:9-2. (Individual or component costs of capital) Compute the cost of the following:
a. Abond that has $1,000 par value (face value) and a contract or coupon interest
rate of 9 percent. A new issue would have a flotation cost of 5 percent of the
$1,100 market value. The bonds mature in 10 years. The firm's average tax rate
is 30 percent, and its marginal tax rate is 34 percent.
b. A new common stock issue that paid a $1.80 dividend last year. The par value
of the stock is $15, and earnings per share have grown at a rate of 7 percent
per year. This growth rate is expected to continue into the foreseeable future.
The company maintains a constant dividend-earnings ratio of 30 percent. The
price of this stock is now $27.50, but 5 percent flotation costs (as a percent of
market price) are anticipated.
c. Internal common equity when 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 percent annual growth rate. The corporation's tax rate is 34 percent.
d. A preferred stock paying a 9 percent dividend on a $150 par value. If a new
issue is offered, flotation costs will be 12 percent of the current price of $175.
e. Abond selling to yield 12 percent after flotation costs, but before adjusting for
the marginal corporate tax rate of 34 percent. In other words, 12 percent is the
rate that equates the net proceeds from the bond with the present value of the
future cash flows (principal and interest).
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