A firm's new financing will be in proportion to the market value of its current financing shown belowThe firm's bonds are currently selling at 80% of par, generating a current market yield of 9%, and the corporation has a 40% tax rate. The preferred stock is selling at its par value and pays a 6% dividend. The common stock has a current market value of $40 and is expected to pay a $1 20 per share dividend this fiscal year. Dividend growth is expected to be 10% per year, and flotation costs are negligible. The firm's weighted-average cost of capital is (round calculations to tenths of a percent)
Answer(s): C
The first step is to determine the after-tax cost of the long-term debt. Multiplying the current yield of 9% times one minus the tax rate (1 -- .4 = .6) results in an after-tax cost of debt of 5.4% (9% x .6). The cost of the preferred stock is 6% (the annual dividend rate). The dividend growth model for measuring the cost of equity capital is a frequently used method that combines the dividend yield with the growth rate. Dividing the $1.20 dividend by the $40 market price produces a dividend yield of 3%. Adding the 3% dividend yield and the 10% growth rate gives a 13% cost of common equity capital. Once the costs of the three types of capital have been computed, the next step is to weight them according to the market values of the elements of the current capital structure. The $1 .000.000 of preferred stock is selling at par. The market value of the long-term debt is 80% of its carrying amount, or $5,600,000 ($7,000,000 x 80%). The common stock has a current market price of $8,000,000 (200,000 shares x $40). Thus, the weighted-average cost of capital is 9.6% ($1,402,000 + $14,600,000), as shown below.
What is the weighted average cost of capital for a firm using 65% common equity with a return of 15%. 25% debt with a return of 6%. 10% preferred stock with a return of 10%.and a tax rate of 35%?
The cost for equity capital is given as 15%, and preferred stock is 10% The before-tax rate for debt is given as 6%. Which translates to an after-tax cost of 3.9% [6% x (1 -- .35)]. The rates are weighted as follows:15% x .65 = 9.75010% x .10 = 1.0003.9% x .25 = .97511.725%
What is the after-tax cost of preferred stock that sells for $5 per share and offers a $0.75 dividend when the tax rate is 35%?
Answer(s): D
Because there is no tax shield associated with preferred stock, the after-tax cost is the same as the before-tax cost.Thus, $75 ÷ $5.00 = 15%. Preferred dividends are not deductible for tax purposes.
What s the weighted average cost of capital for a firm with equal amounts of debt and equity financing, a 15% before-tax company cost of equity capital, a 35% tax rate, and a 12% coupon rate on its debt that is selling at par value?
The 12% debt coupon rate is reduced by the 35% tax shield, resulting in a cost of debt of 78% [12% x (1 -- .35)1 The average of the 15% equity capital and 7.8% debt is 11.4%
What is the weighted average cost of capital for a firm with 40% debt. 20% preferred stock, and 40% common equity if the respective costs for these components are 8% after- tax, 13% after-tax, and 17% before-tax'? The firm's tax rate is 35%
All three rates are quoted as after-tax rates since there is no tax shield associated with common equity capital. Thus, simply weight the three rates to determine the weighted average cost.
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