Please, I need help with the following question. Thank you for all those who you
ID: 2740986 • Letter: P
Question
Please, I need help with the following question. Thank you for all those who you have helped!
The Allied Group intends to expand the company's operation by making significant investments in several opportunities available to the group. Accordingly, the group has identified a need for additional financing in preferred and new common stock and new bond issues. The risk-free rate for the company is 7%, and the appropriate tax rate is 40%. Also, the beta coefficient for the company is 1.3 and the market risk premium (Km) is 12.
New Debt
The company has been advised that new bonds can be sold on the market at par ($1000) with an annual coupon of 8%, for 30 years.
New Common Stock
Market analysis has determined that given the positive history of the firm, new common stock can be sold at $29 per share, with the last dividend being paid of $2.25 per share. The growth rate on any new common stock has been estimated at a constant rate of 15% per year for the next 3 years.
Preferred Stock
New Preferred Stock can be issued with an annual dividend of 10% of par and is paid annually and currently would sell for $90 per share.
QUESTION:
What is the after tax component cost as a percentage (e.g., interest rate) of new debt today?
Explanation / Answer
After tax cost of Debt= Before tax cost*(1-tax rate)
Since bonds are sold at par Cost= coupon rate
After tax cost of Debt=0.08*(1-0.4) = 0.048 =4.8%