The treasurer of Riley Coal Co. 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 4 percent less than that for preferred stock. Debt can be issued at a yield of 12.0 percent, and the corporate tax rate is 25 percent. Preferred stock will be priced at $62 and pay a dividend of $7.40. The flotation cost on the preferred stock is $7.

a) Compute the aftertax cost of debt. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

Question

Business

Dunn

28 June, 15:28

The treasurer of Riley Coal Co. 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 4 percent less than that for preferred stock. Debt can be issued at a yield of 12.0 percent, and the corporate tax rate is 25 percent. Preferred stock will be priced at $62 and pay a dividend of $7.40. The flotation cost on the preferred stock is $7.

a) Compute the aftertax cost of debt. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

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Miller · Answer 1

Answer: the after-tax cost of debt = kd (1=T)

= 12 (1-0.25)

= 12 (0.75)

= 9%

The after-tax cost of debt is 9%

Explanation: The after-tax cost of debt equals cost of debt multiplied by 1-corporate tax rate. The cost of preferred stock is 13.45% ie kp = D/Po-Fc = 7.40/62-7. The after-tax cost of debt is at least 4% less than the cost of preferred stocks. The variables are defined as follows:

kd = Cost of debt

kp = Cost of preferred stocks

Po = Market value of preferred stocks

T = Corporate tax rate

Fc = Flotation cost