1. The Dentite Corporation’s bonds are currently selling to yield new buyers a 12% return on their investment. Dentite’s marginal tax rate including both federal and state taxes is 38%. What is the firm’s cost of debt?
12. Kleig Inc.’s bonds are selling to yield 9%. The firm plans to sell new bonds to the general public and will therefore incur flotation costs of 6%. The company’s marginal tax rate is 42%.
a. What is Kleig’s cost of debt with respect to the new bonds? (Hint: Adjust the cost of debt formula to include flotation costs.)
b. Suppose Kleig also borrows directly from a bank at 12%.
1. What is its cost of debt with respect to such bank loans? (Hint: Would bank loans be subject to flotation costs?)
2. If total borrowing is 60% through bonds and 40% from the bank, what is Kleig’s overall cost of debt? (Hint: Think weighted average.)
Cost of Preferred Stock: Example 13-4 (page 568)
13. Harris Inc.’s preferred stock was issued five years ago to yield 9%. Investors buying those shares on the secondary market today are getting a 14% return. Harris generally pays flotation costs of 12% on new securities issues. What is Harris’s cost of preferred financing?
14. Fuller, Inc. issued $100, 8% preferred stock five years ago. It is currently selling for $84.50. Assuming Fuller has to pay floatation costs of 10%, what is Fuller’s cost of preferred stock?
15. A few years ago Hendersen Corp issued preferred stock paying 8% of its par value of $50. The issue is currently selling for $38. Preferred stock flotation costs are 15% of the proceeds of the sale. What is Hendersen’s cost of preferred stock?
16. New buyers of Simmonds Inc. stock expect a return of about 22%. The firm pays flotation costs of 9% when it issues new securities. What is Simmonds’ cost of equity (Hint: This problem is very simple since we don’t have to estimate the investors’ return.)
a. From retained earnings?
b. From new stock?
17. Klints Inc. paid an annual dividend of $1.45 last year. The firm’s stock sells for $29.50 per share, and the company is expected to grow at about 4% per year into the foreseeable future. Estimate Klints’ cost of retained earnings.
Cost of RE and New Stock: Examples 13-6 and 13-8 (pages 570 and 572)
18. The Pepperpot Company’s stock is selling for $52. Its last dividend was $4.50, and the firm is expected to grow at 7% indefinitely. Flotation costs associated with the sale of common stock are 10% of the proceeds raised. Estimate Pepperpot’s cost of equity from retained earnings and from the sale of new stock.
19. The Longlife Insurance Company has a beta of .8. The average stock currently returns 15% and short-term treasury bills are offering 6%. Estimate Longlife’s cost of retained earnings.
20. The Longlife Insurance Company of the preceding problem has several bonds outstanding that are currently selling to yield 9%. What does this imply about the cost of the firm’s equity?
21. Hammell Industries has been using 10% as its cost of retained earnings for a number of years. Management has decided to revisit this decision based on recent changes in financial markets. An average stock is currently earning 8%, treasury bills yield 3.5%, and shares of Hammell’s stock are selling for $29.44. The firm just paid a dividend of $1.50, and anticipates growing at 5% for the foreseeable future. Hammell’s CFO recently asked an investment banker about issuing bonds and was told the market was demanding a 6.5% coupon rate on similar issues. Hammell stock has a beta of 1.4. Recommend a cost of retained earnings for Hammell.