Situation

During the last few years, Harry Davis Industries has been too constrained by the high cost of capital to make many capital investments. Recently, though, capital costs have been declining, and the company has decided to look seriously at a major expansion program that has been proposed by the marketing department. Assume that you are an assistant to Leigh Jones, the financial vice president. Your first task is to estimate Harry Davis's cost of capital. Jones has provided you with the following data, which she believes may be relevant to your task:

$(1)$ The firm's tax rate is $40\%.$

$(2)$ The current price of Harry Davis's $12\%$ coupon, semiannual payment, noncallable bonds with $15$ years remaining to maturity is $$1,153\mathrm{.}72.$ The face value is $$1000.$

$(3)$ The current price of the firm$$s $10\%,$ $$100$ par value, quarterly dividend, perpetual preferred stock is $$116\mathrm{.}95.$

$(4)$ Harry Davis's common stock is currently selling at $$50$ per share. Its last dividend $($D$0)$ was $$3\mathrm{.}12,$ and dividends are expected to grow at a constant rate of $5\mathrm{.}8\%$ in the foreseeable future. Harry Davis's beta is $1\mathrm{.}2,$ the yield on T$-$bonds is $5\mathrm{.}6\%,$ and the market risk premium is estimated to be $6\%.$ For the over$-$own$-$bond$-$yield$-$plus$-$judgmental$-$risk$-$premium approach, the firm uses a $3\mathrm{.}2\%$ judgmental risk premium.

$"1.$ What is the market interest rate on Harry Davis's debt and what is the component cost of this debt for WACC

purposes?"

COST OF DEBT, kd

N risk $=$

PV $=$

PMT $=$

FV $=$ kd $=$

The relevant cost of debt is the after$-$tax cost of new debt, taking account of the tax deductibility of interest. The after$-$tax rate is calculated by multiplying the interest rate $($or the before$-$tax cost of debt$)$ times one minus the tax rate.

B$-$T kd $=$

Tax rate $=$

A$-$T kd $=(1$ Tax rate$)$ x $($B$-$T kd$)$

A$-$T kd $=$ x

A$-$T kd $=$