# Cost of Capital

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ILLUSTRATION 1 COMPUTE THE COST FOR THE FOLLOWING: a. A bond that has a Rs 1,000 par value (face value) and coupon interest rate of 12 percent. A new issue would have a flotation cost of 5 percent of the Rs 1,100 market value. The bonds mature in 10 years The firm's average tax rate is 25 percent and its marginal tax rate is 30 percent. b. A preferred stock paying a 9 percent dividend on a Rs 100 par value. If a new issue is offered, flotation costs will be 5 percent of the current price of Rs 125. c. Internal common equity where the current market price of the common stock is Rs 60 The expected dividend for coming year should be Rs 6, increasing thereafter at a 8 percent annual growth rate. The corporation's tax rate is 30 percent. d. A new common stock issue that paid a Rs 12 dividend last year. The par value of the stock is Rs 100, and earnings per share have grown at a rate of 6 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 Rs 110, but 5 percent flotation costs are anticipated.
Solution
A. GIVEN, Par value = Rs 1,000 Coupon interest = 12% Flotation cost = 5% of Rs 1100 = Rs 55 Maturity period (n) = 10 years Marginal tax rate = 30% Average tax rate = 25% Net proceed (NP) = Selling price – Flotation cost = Rs 1,100 – Rs 55 = Rs 1,045 Cost of debt? Cost of debt before-tax (kd) = = = = 0.1121 or 11.21% Cost of debt after-tax (kdt) = Cost of debt before-tax (1 – t) = 11.21% (1 - 0.3) = 7.85% b. Given,…...

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