The Exciting Calculation of Cost of Capital for a Firm
What is the cost of capital for the firm based on the following data?
a. Currently bonds with a similar credit rating and maturity as the firm's outstanding debt are selling to yield 7.62 percent while the borrowing firm's corporate tax rate is 34 percent. b. Common stock for a firm that paid a $1.01 dividend last year with expected growth of 5.5 percent per year. The current stock price is $24.89. c. A bond with a coupon interest rate of 11.5 percent, selling at $1,153 per bond, and maturing in 20 years with a tax rate of 34 percent. d. A preferred stock paying a dividend of 7.4 percent on a $107 par.
Answer:
The cost of capital for the firm cannot be calculated without the information about the market values of each source of financing.
Explanation:
The cost of capital for a firm is calculated by considering the costs of different sources of financing such as debt, equity, and preferred stock. The cost of debt is the interest rate paid by the firm on its debt, adjusted for tax savings from the interest expense. The cost of equity is the return required by shareholders to invest in the firm's common stock. The cost of preferred stock is the dividend rate paid on the preferred stock.
To determine the cost of capital, the weights of each source of financing are multiplied by their respective costs. These weights are usually based on the market value of each source of financing.
In this case, we have information on four sources of financing: bonds, common stock, bonds with a coupon interest rate, and preferred stock. The costs of debt, equity, and preferred stock are calculated based on the given data.
However, without the market values of each source of financing, it is not possible to calculate the cost of capital for the firm. Market values are crucial in determining the appropriate weights of each source of financing in the overall capital structure.