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Cash754
 
Posts: 2,600
Default please help me answer - cost of capital

a)Issue common stock. The price of the existing shares of the company is RM50. The expected dividend for the next year is RM3.50 and the growth rate will remain at 10%. The flotation cost is 5% of the issue price.

Ksubc "cost of external equity" = [D1/(P0(1 - F)] + g
Ksubc = [3.50 / (50(1 - 0.05)] + 0.10
= (3.50 / 52.63158) + 0.10
= 0.0665 + 0.10
= 0.1665, or 16.65%

b. Issue 8% coupon interest bond of 10 years. The market price of a similar bond is RM1,000. The current tax bracket of the firm is 40%
market rate = coupon rate since the bond is selling at par of 1,000
after tax rate of debt = 0.08 * (1 - tx)
= 0.08 * (1 - 0.40)
= 0.048, or 4.8%



c. Issue a 15% preferred stock with a par value of RM90. The flotation cost is 3% of the par value and the market price is RM140.
dividend on preferred stock = 90 * 0.15 = 13.50
3% of par value: 90 * 0.03 = 2.70 <flotation costs...2.70 / 140 = 0.01929, or 1.929% of market value

cost of preferred stock with flotation costs: 13.50 / 140(1 - 0.01929) = 13.50/137.30 = 0.09832, or 9.832%

..obviously the bond (debt) is the least expensive way to fund the project

2. You are considering two financing proposals. The first proposal that you are analyzing is a preferred stock that sells for RM100 and pays annual dividend of RM15. The second proposal is a common stock that recently paid a RM6 dividend and the stock is selling for RM50. The rate of growth in earnings for this common stock is 5%.

a. Calculate the cost of issuing common stock....Use Gordon growth model...
P0 = D1 / (r - g)
50 = 6(1.05) / (r - 0.05)
6.30 / 50 = r - 0.05
0.126 = r - 0.05
r = 0.176, or 17.6%
b. Calculate the cost of issuing preferred stock.
P0 = div / r
100 = 15 / r
r = 15/100
r = 0.15, or 15%
c. Which financing proposal to be accepted and why? Finance with preferred stock, it's your lowest cost of capital between the two options.
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