11-3

Russell Container Corporation has a $1,000 par value bond outstanding with 20 years to maturity. The bond carries an annual interest payment of $128 and is currently selling for $780 per bond. Russell Corp. is in a 20 percent tax bracket. The firm wishes to know what the aftertax cost of a new bond issue is likely to be. The yield to maturity on the new issue will be the same as the yield to maturity on the old issue because the risk and maturity date will be similar.

a.Compute the yield to maturity on the old issue and use this as the yield for the new issue.(Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

Yield to Maturity= (%)

b.Make the appropriate tax adjustment to determine the aftertax cost of debt.(Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

Aftertax cost of debt= (%)

11-8

A-Rod Manufacturing Company is trying to calculate its cost of capital for use in making a capital budgeting decision. Mr. Jeter, the vice-president of finance, has given you the following information and has asked you to compute the weighted average cost of capital.

The company currently has outstanding a bond with a 11.6 percent coupon rate and another bond with an 9.2 percent rate. The firm has been informed by its investment banker that bonds of equal risk and credit rating are now selling to yield 12.5 percent. The common stock has a price of $70 and an expected dividend (D₁) of $1.90 per share. The historical growth pattern (g) for dividends is as follows:

$1.451.591.741.90

The preferred stock is selling at $90 per share and pays a dividend of $8.60 per share. The corporate tax rate is 30 percent. The flotation cost is 3.0 percent of the selling price for preferred stock. The optimal capital structure for the firm is 25 percent debt, 10 percent preferred stock, and 65 percent common equity in the form of retained earnings.

a.Compute the historical growth rate.(Do not round intermediate calculations. Round your answer to the nearest whole percent and use this value asg. Input your answer as a whole percent.)

Growth Rate= %

b.Compute the cost of capital for the individual components in the capital structure.(Use the rounded whole percent computed in part a forg. Do not round any other intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)

Weighted Cost

Debt ________ %

Preferred stock _________

Common equity __________

c.Calculate the weighted cost of each source of capital and the weighted average cost of capital.(Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)

Weighted Cost

Debt ________ %

Preferred stock _________

Common equity __________

Weighted average cost of capital 0.00%