QUESTION 5 (20 MARKS)

(a) Compute the cost for the following sources of financing: (8 marks) i. A $100 par value bond with a market price of $97 and a coupon interest rate of 10%. Costs for a new issue would be approximately 5%. The bonds mature in ten years and the corporate tax rate is 30%. Estimate the cost of debt before tax. ii. Preference shares selling for $10 with an annual dividend payment of $0.80. If the company sells a new issue the cost will be $0.90 per share. iii. Internally generated equity totalling $4.8 million. The price of ordinary shares is $7.50 per share, and the dividends per share were $0.98 last year. These dividends are not expected to increase. iv. New ordinary shares where the most recent dividend was $0.28. The company's dividends per share should continue to increase at an 8% growth rate into the indefinite future. The market price of the shares is currently $5.30; however, issue costs of $0.60 per share are expected if the new shares are issued. Estimate the after-tax cost of ordinary shares, assuming that the dividends are constant.

(b) The following information comes from the XY balance sheet. The value of common stock is $10,000, retained earnings equals $7,000, total common equity equals $17,000, preferred stock has a value of $3,000, and long-term debt totals $15,000. If the cost of debt is 8.00%, preferred stock has a cost of 10.00%, common stock has a cost of 12.00%, and the firm has a corporate tax rate of 30%. Compute the firm's WACC adjusted for taxes.

(c) Explain how flotation costs are used when estimating a firm's yield-to-maturity. (6 marks)