Revision Chapter 9

Revision Long Term Financing

Open Ended

Currently, Warren Industries can sell 15-year, $1,000-par-value bonds paying annual interest at a 12% coupon rate. As a result of current interest rates, the bonds can be sold at 1% premium; issuance costs of $30 per bond will be incurred in this process. The firm is in the 40% tax bracket. Estimate the before tax and after-tax cost of debt.

Kd =120+ (1000-1010-30)/15

(1000+1010-30)/2

Kd= 11.85%

Kd before tax

Face value = $1000

Bond price = $1000 x (1+1%) = $ 1010

Coupon payment =12% x$1000 = $120

N=15 years

Flotation cost = $30

Tax = 40%

List the information

Solution

Kd (1-Tax) = 11.85 (1-0.4) =7.11%

Kd after-tax

Face value = $1000

Bond price = $1000 x (1+1%) = $ 1010

Coupon payment =12% x$1000 = $120

N=15 years

Flotation cost = $30

Tax = 40%

List the information

Solution

Open Ended

The company can issue $1,000-par-value, 5-year bonds that can be

sold for $1,200 each. The current yield of the bond is 8.33%. Flotation costs would amount to $25.00 per bond. Currently, the tax rate is 40%. Calculate the after-tax cost of debt financing.

Solution

Given: Face value = $1000 ; N= 5 years; Bond Price = $1200;

Bond current yield = 8.5%; Flotation cost = $25 per bond

Current yield = coupon payment / bond price = 0.085

Coupon payment = Bond price x current yield = 0.085 x 1200 = $102

Kd = 102 + (1000-1200-25)/5 = 5.24%

(1000+1200-25)/2

Solution

Given: Face value = $1000 ; N= 5 years; Bond Price = $1200;

Bond current yield = 8.5%; Flotation cost = $25 per bond

After tax cost of debt = 5.24 (1-0.4) =3.14%

Open Ended

The firm can sell for $980 a 10-year, $1,000-par-value bond paying annual interest at a 10% coupon rate. A flotation cost of 3% of the par value is required in addition to the discount of $20 per bond. Calculate the before-tax cost of debt.

Answer: 10.05%

Open Ended

Eight percent (annual dividend) preferred stock having a par value of $100 can be sold for $65. An additional fee of $2 per share must be paid to the underwriters.

Open Ended

The firm can sell 8% preferred stock at its $90-per-share par value (or 10% discount). The cost of issuing and selling the preferred stock is expected to be $5 per share. Compute the cost of issuing preferred stocks.

Open Ended

The firm’s common stock is currently selling for $90 per share. The firm expects to pay cash dividends of $7 per share next year. The firm’s dividends have been growing at an annual rate of 6%, and this growth is expected to continue into the future. The stock must be underpriced by $7 per share, and flotation costs are expected to amount to $5 per share. The firm can sell new common stock under these terms.

Open Ended

The company can issue $2.00 dividend preferred stock for a market price of

$25.00 per share. Flotation costs would amount to $3.00 per share. What is the

cost of preferred stock financing?

Open Ended

The current price of Nova’s common stock is $35 per share. Currently, the dividend yield is 3.5%. The firm’s dividends have grown at an annual rate of 5%, and it is expected that the dividend will continue at this rate for the foreseeable future. The flotation costs are expected to be approximately $2 per share. Compute the cost of common stock.