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(Individual or component costs of capital) Compute the cost of the following:

a. A bond 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 thereafter 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. A bond 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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