Problem: (Individual or component costs of capital) Compute the cost of the following:
Question 1: A bond selling to yield 7 percent after flotation costs, but before adjusting for the marginal corporate tax rate of 34 percent. In other words, 7 percent is the rate that equates the net proceeds from the bond with the present value of the future cash flows (principal and interest).
Question 2: A new common stock issue that paid a $1.05 dividend last year. The par value of the stock is $2, and the earnings per share have grown at a rate of 4 percent per year. This growth rate is expected to continue into the foreseeable future. The company maintains a constant dividend-earnings ratio of 40 percent. The price of this stock is now $30, but 9 percent flotation costs are anticipated.
Question 3: A bond that has a $1,000 par value and a contract, or coupon, interest rate of 12 percent. A new issue would net the company 90 percent of the $1,150 market value. The bonds mature in 15 years, the firm's average tax rate is 30 percent, and its marginal tax rate is 34 percent.
Question 4: A preferred stock paying a 6 percent dividend on a $100 par value. If a new issue is offered, the company can expect to net $85 per share.
Question 5: Internal common equity when the current market price of the common stock is $35. The expected dividend this coming year should be $4, increasing thereafter at a 4 percent annual growth rate. The corporation's tax rate is 34 percent.