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Cost of Capital - Solutions3

# Cost of Capital - Solutions3 - KS = 0.04(0.05(1.2 = 10...

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Old Exam Questions - Cost of Capital - Solutions Page 7 of 42 Pages K S = 0.04 + (0.05)(1.2) = 10% Alternatively, g = (0.10)(1 – 0.50) = 5% K S = \$2.20 / \$44.00 + 0.05 = 0.05 + 0.05 = 10% K e = \$2.20 / (\$44.00)(1-0.10) + 0.05 = 10.56% Therefore, WACC = (4.8%)(0.40) + (10.0%)(0.40) + (10.56%)(0.20) = 1.92% + 4.0% + 2.112% = 8.032% 3. Your company plans to issue debt with an annual coupon rate of 8.5% (interest paid semi-annually) and which will mature in 20 years at a par value of \$1,000. Your firm’s investment bankers have stated that the bonds can be sold publicly to investors at a price of \$980 per bond, but that the firm will be required to pay a flotation expense to the investment bankers equal to 2% of this price. If the firm has a marginal corporate tax rate of 35%, then what will be the firm’s after-tax cost on this new debt to be issued? A. 5.35% B. 5.50% C. 5.65% * D. 5.80% E. 5.95% Net Price = (\$980) (1 - .02) = \$960.40 N = 40 PV = -\$960.40 PMT = (\$85 / 2) = \$42.50 FV = \$1,000 Solve for I/YR = 4.464097130% K D = (4.464097130) (2) = 8.928194260% After-tax K D = (8.928194260) (1 – 0.35) = 5.803326269% = 5.80% YOU ARE GIVEN THE FOLLOWING INFORMATION FOR PROBLEMS 4 - 5: Your company's current market-valued capital structure, which is considered to be optimal, is shown below:

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Old Exam Questions - Cost of Capital - Solutions Page 8 of 42 Pages Debt 40% Preferred Stock 10% Equity 50% In order to meet their expansion plans for next year, the company has decided to raise \$5,000,000. Net Income is expected to be \$550,000 next year. However, preferred stock dividends are expected to account for \$50,000 of this profit. The common stock
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