COST of Capital Q and A

9-1 a. rd(1 - T) = 7%(1 - 0) = 7.0%.

b. rd(1 - T) = 7%(0.80) = 5.6%.

c. rd(1 - T) = 7%(0.65) = 4.6%.

9-2 rd(1 - T) = 0.095(0.70) = 6.7%.

9-3 Vps = $25; Dps = $1.75; F = 0%; rps = ?

D ps
rps =
Vps (1 F)
$1.75
=
$25 (1 0.0)
= 7%.

$50 (0.06 ) $3.00

9-4 rps = = = 5.26%.
$60 .00 (1 0.05 ) $57.00
9-5 P0 = $36; D1 = $3.00; g = 5%; rs = ?

D1
rs = + g = ($3.00/$36.00) + 0.05 = 13.33%.
P0

9-6 rs = rRF + bi(RPM) = 0.06 + 0.8(0.055) = 10.4%.

9-7 30% Debt; 5% Preferred Stock; 65% Equity; rd = 6%; T = 30%; rps = 5.8%; rs = 12%.

WACC = (wd)(rd)(1 - T) + (wps)(rps) + (wce)(rs)

WACC = 0.30(0.06)(1-0.30) + 0.05(0.058) + 0.65(0.12) = 9.35%.

9-8 40% Debt; 60% Equity; rd = 9%; T = 30%; WACC = 10.32%; rs = ?

WACC = (wd)(rd)(1 - T) + (wce)(rs)

10.32% = (0.4)(9%)(1 - 0.3) + (0.6)rs
10.32% = 2.52% + 0.6rs
7.8% = 0.6rs
rs = 13%.

9-9 N = 60, PV = -821.97, PMT = 30, and FV = 1000, to get I = 3.75% = periodic rate. The nominal
rate is 3.75%(2) = 7.50%, and the after-tax component cost of debt is 7.50%(0.70) = 5.25%.

9-11 Q Radon Homes current EPS is $6.50. It was $4.42 5 years ago. The company pays out 40% of its
earnings as dividends, and the stock sells for $36.
a. Calculate the past growth rate in earnings. (Hint: This is a 5-year growth period.)
b. Calculate the next expected dividend per share, D1 Assume that the past growth rate will
Continue.
c. What is the cost of equity, rs, for Radon Homes?

9-11 A a. $6.50 = $4.42(1+g)5

(1+g)5 = 6.50/4.42 = 1.471
(1+g) = 1.471(1/5) = 1.080
g = 8%.

Alternatively, with a financial calculator, input N = 5, PV = -4.42, PMT = 0,

FV = 6.50, and then solve for I = 8.02% 8%.

b. D1 = D0(1 + g) = $2.60(1.08) = $2.81.

c. rs = D1/P0 + g = $2.81/$36.00 + 8% = 15.81%.