Mead Corporation is planning to issue debt that will mature in the year 2025. In many respects the issue is similar to currently outstand ing debt of the corporation. Using Table 11-2 in the chapter, a. Identify the yield to maturity on similarly outstand ing debt for the firm, in b. Assume that because the new debt will be issued at par, the required yield to maturity will be 0. 15 percent higher than the value determined in part a Add this factor to the answer in a(New issues at par sometimes require a slightly higher yield than old issues that are trading below par. There is less leverage and fewer tax advantages. c. If the firm is in a 30 percent tax bracket, what is the aftertax cost of debt? Solution: Mead Corporation a.7.51% b.7.51%+.15%=7.66% Kd= Yield(1 766%(1-30 766%(70) 5.36% CopyrightC2005 by The McGraw-Hill Companies, Inc
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-389 11-9. Mead Corporation is planning to issue debt that will mature in the year 2025. In many respects the issue is similar to currently outstanding debt of the corporation. Using Table 11-2 in the chapter, a. Identify the yield to maturity on similarly outstanding debt for the firm, in terms of maturity. b. Assume that because the new debt will be issued at par, the required yield to maturity will be 0.15 percent higher than the value determined in part a. Add this factor to the answer in a. (New issues at par sometimes require a slightly higher yield than old issues that are trading below par. There is less leverage and fewer tax advantages.) c. If the firm is in a 30 percent tax bracket, what is the aftertax cost of debt? Solution: Mead Corporation a. 7.51% b. 7.51% + .15% = 7.66% c. Kd = Yield (1 – T) = 7.66% (1 – .30) = 7.66% (.70) = 5.36%
11-10 Burger Queen can sell preferred stock for $70 with an estimated flotation cost of $2.50. It is anticipated that the preferred stock will pay $6 per share in dividends a. Compute the cost of preferred stock for Burger Queen b. Do we need to make a tax adjustment for the issuing firm? Solution: Burger Queen D K P-F 6.00 $70.00-$2.50 $67.50 8.89% b. No tax adjustment is required Preferred stock dividends are not a tax deductible expense for the issuing firm(the dividends, of course are 70 percent tax exempt to a corporate recipient) CopyrightC 2005 by The McGray-Hill Companies, Inc
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-390 11-10. Burger Queen can sell preferred stock for $70 with an estimated flotation cost of $2.50. It is anticipated that the preferred stock will pay $6 per share in dividends. a. Compute the cost of preferred stock for Burger Queen. b. Do we need to make a tax adjustment for the issuing firm? Solution: Burger Queen 8.89% $67.50 $6.00 $70.00 $2.50 $6.00 P F D a. K p p p = = − = − = b. No tax adjustment is required. Preferred stock dividends are not a tax deductible expense for the issuing firm (the dividends, of course, are 70 percent tax exempt to a corporate recipient)
Wallace Container Company issued $100 par value preferred stock 12 years ago. The stock provided a 9 percent yield at the time of issue. The preferred stock is now selling for $72. What is the current yield or cost of the preferred stock? ( Disregard flotation costs. Solution: Wallace Container Company D Yield==P==12.5% P$72 l1-12 The treasurer of Bio Science, Inc, is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 2 percent less than that for preferred stock Based on the following facts. is she correct? Debt can be issued at a yield of 1l percent, and the corporate tax rate is 30 percent. Preferred stock will be priced at $50, and pay a dividend of$4.80. The floatation cost on the preferred stock is $2.10 Solutio Bio Science. Inc. Aftertax cost of debt Kd =Yield ( 11%(1-30)=11%(.70)=7.70% ftertax cost of preferred stock K $4.80 $4.80 10.02 $50-$2.10$47.90 Yes, the treasurer is correct. The difference is 2. 32%(7.70% versus 10.02%) S-391 CopyrightC2005 by The McGraw-Hill Companies, Inc
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-391 11-11. Wallace Container Company issued $100 par value preferred stock 12 years ago. The stock provided a 9 percent yield at the time of issue. The preferred stock is now selling for $72. What is the current yield or cost of the preferred stock? (Disregard flotation costs.) Solution: Wallace Container Company 12.5% $72 $9 P D Yield p p = = = 11-12. The treasurer of Bio Science, Inc., is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 2 percent less than that for preferred stock. Based on the following facts, is she correct? Debt can be issued at a yield of 11 percent, and the corporate tax rate is 30 percent. Preferred stock will be priced at $50, and pay a dividend of $4.80. The floatation cost on the preferred stock is $2.10. Solution: Bio Science, Inc. Aftertax cost of debt Kd = Yield (1 – T) = 11% (1 – .30) = 11% (.70) = 7.70% Aftertax cost of preferred stock 10.02% $47.90 $4.80 $50 $2.10 $4.80 P F D K p p p = = − = − = Yes, the treasurer is correct. The difference is 2.32% (7.70% versus 10.02%)
11-13 Murray Motor Company wants you to calculate its cost of common stock During the next 12 months, the company expects to pay dividends ( di)of $2.50 er share, and the current price of its common stock is $50 per share. The expected growth rate is percent a. Compute the cost of retained earnings( Ke). Use Formula 11-6 b. If a $3 floatation cost is involved, compute the cost of new common stock (Kn). Use Formula 11-7 Solution: Murray motor co aK_ D g $2.50 Ss0+8%=5%+8%=13% D b. K g $2.50 $2.50 +8%= +8% $50-$3 $47 =5.32%+8%=13.32% CopyrightC 2005 by The McGray-Hill Companies, Inc. -392
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-392 11-13. Murray Motor Company wants you to calculate its cost of common stock. During the next 12 months, the company expects to pay dividends (D1) of $2.50 per share, and the current price of its common stock is $50 per share. The expected growth rate is 8 percent. a. Compute the cost of retained earnings (Ke). Use Formula 11-6. b. If a $3 floatation cost is involved, compute the cost of new common stock (Kn). Use Formula 11-7. Solution: Murray Motor Co. 8% 5% 8% 13% $50 $2.50 g P D a. K 0 1 e = + = + = = + 5.32% 8% 13.32% 8% $47 $2.50 8% $50 $3 $2.50 g P F D b. K 0 1 n = + = + = + − = + − =