Scribd Logo
Upload

Welcome to Scribd!

  • 816 views

    COst of Capital

    Uploaded by

    Lito Jose Perez Lalantacon
    This document contains information about a company's capital structure including bonds, preferred stock, common stock, and retained earnings. It then calculates: 1) The cost of bonds as 4.2% based on the interest rate net of taxes. 2) The cost of preferred stock as 10% based on the dividend yield. 3) The cost of retained earnings as 13.95% and the cost of new common stock as 14.83%, both based on dividend growth rates and market prices. 4) The weighted average cost of capital is calculated to be 10.99% based on the individual costs and market values of each source of capital. This rate will be used to evaluate potential projects.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd

    COst of Capital

    Uploaded by

    Lito Jose Perez Lalantacon
    816 views3 pages
    This document contains information about a company's capital structure including bonds, preferred stock, common stock, and retained earnings. It then calculates: 1) The cost of bonds as 4.2% based on the interest rate net of taxes. 2) The cost of preferred stock as 10% based on the dividend yield. 3) The cost of retained earnings as 13.95% and the cost of new common stock as 14.83%, both based on dividend growth rates and market prices. 4) The weighted average cost of capital is calculated to be 10.99% based on the individual costs and market values of each source of capital. This rate will be used to evaluate potential projects.

    Original Title

    COst of Capital.docx

    Copyright

    © © All Rights Reserved

    Available Formats

    DOCX, PDF, TXT or read online from Scribd

    Read this document in other languages

    Did you find this document useful?

    Is this content inappropriate?

    This document contains information about a company's capital structure including bonds, preferred stock, common stock, and retained earnings. It then calculates: 1) The cost of bonds as 4.2% based on the interest rate net of taxes. 2) The cost of preferred stock as 10% based on the dividend yield. 3) The cost of retained earnings as 13.95% and the cost of new common stock as 14.83%, both based on dividend growth rates and market prices. 4) The weighted average cost of capital is calculated to be 10.99% based on the individual costs and market values of each source of capital. This rate will be used to evaluate potential projects.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    816 views3 pages

    COst of Capital

    Uploaded by

    Lito Jose Perez Lalantacon
    This document contains information about a company's capital structure including bonds, preferred stock, common stock, and retained earnings. It then calculates: 1) The cost of bonds as 4.2% based on the interest rate net of taxes. 2) The cost of preferred stock as 10% based on the dividend yield. 3) The cost of retained earnings as 13.95% and the cost of new common stock as 14.83%, both based on dividend growth rates and market prices. 4) The weighted average cost of capital is calculated to be 10.99% based on the individual costs and market values of each source of capital. This rate will be used to evaluate potential projects.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    You are on page 1of 3
    At a glance
    Powered by AI
    The key takeaways are how to calculate the cost of different sources of capital (bonds, preferred stock, common stock, retained earnings) and how to calculate the weighted average cost of capital (WACC).

    The cost of bonds is calculated as the pre-tax interest rate (7%) times 1 minus the tax rate (1 - 0.4) which equals 4.2%.

    The cost of preferred stock is calculated as the dividend per share ($5) divided by the market price per share ($50) which equals 10%.

    Students Name: Amorillo, Jay Romano

                     Garcia, Julie Fe


                     German, Joan
                     Ranises, Yuri Lazaro Jr.
    Subject: BA 2103: Financial Management
    Professor: Rosfe Corlae Badoy
     

    The Gamma Products Corporation has the following capital structure, which it considers

    optimal:

    Bonds, 7% (now selling at par) $ 300,000

    Preferred Stock,   $5.00 240,000

    Common Stock                       360,000

    Retained Earnings                   300,000

    --------------

    $1,200,000

      =========

    Dividends on common stock are currently at $3 per share and are expected to grow at a
    constant rate of 6 percent. Market price per share of common stock is $40, and the
    preferred stock isselling at $50. Flotation cost on new issues of common stock is 10
    percent. The interest on bonds is paid annually. The company’s tax rate is 40 percent.

    a.     Cost of Bonds

    Kd =   r BT (1-T)
    d

          =  7% (1-0.40)

    Kd =   4.20%

    Interest is a tax deductible expenses, as such the cost of debt should be net of
    tax.
    b.    Cost of Preferred Stock

    Cost of Preferred Dividend per share


    =
    Stock Market Price per share, net

    $5
    =
    $50

    = 10%

    It is the preference share “yield rate”. The market price of the stock serve as the
    cost of investment.

    c.     Cost of Retained Earnings (internal equity)

    Ks   = D1   + g
    Po
                 = 3(1+0.06) + 0.06
                       40

      Ks  = 0.1395 or 13.95%

    The cost of Retained earnings to finance the capital investment is 13.95%. In this
    computation, the denomination used is the market price of the shares without
    deducting the flotation cost.

    d.    Cost of New Common Stock (external equity)

          Kn =   D1   + g
                    Po-F
             =  3(1+0.06) + 0.06
                       40-4

          =   0.1483 OR 14.83%

    Ordinary shareholders are the real owners of the business organizations. If the
    business fails, ordinary shareholders absorb the greatest impairment in equity. If
    the business grows, ordinary shareholders register the greatest increase in
    wealth. That is why the growth rate is factored in the cost of using ordinary
    equity.

     e.     Weighted Average Cost of Capital

    Individual Cost of Capital


    Source of Capital Market Values Weighted Average cost of Capital
    Capital Fraction
    Bonds $300,000 4.20% 25% 1.05%
    Preferred Stock $240,000 10.00% 20% 2.00%
    Common Stock $360,000 14.83% 30% 4.45%
    Retained
    $300,000 13.95% 25% 3.49%
    Earnings
    Total $1,200,000     10.99%

    The individual cost of capital does not serve as a meaningful basis in evaluating
    projects for the interest of the business organization as a whole. The basis used
    in evaluating project proposals would be the weighted average cost of capital.
    The 10.99% represents the minimum return on investment that a proposed project
    should provide to be acceptable. The lower the cost of capital the better it would
    -be for the business, this cost of capital serves as a benchmark in evaluating
    proposed investment. To be acceptable, a project must have a rate of return on
    investment greater than its cost of capital.

    You might also like