THE COST OF CAPITAL PROBLEM EXERCISES

1. AFTER-TAX COST OF DEBT. The Holmes Company's currently outstanding bonds have an 8% coupon and a 10% yield to maturity. Holmes believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 40%, what is Holmes' after-tax cost of debt?

2. COST OF PREFERRED STOCK. Torch Industries can issue perpetual preferred stock at a price of $57.00 a share. The stock would pay a constant annual dividend of $6.00 a share.

What is the company's cost of preferred stock?

3. COST OF COMMON EQUITY. Pearson Motors has a target capital structure of 30% debt and 70% common equity, with no preferred stock. The yield to maturity on the company's outstanding bonds is 9%, and its tax rate is 40%. Pearson's CFO estimates that the company's WACC is 10.50%. What is Pearson's cost of common equity?

4. COST OF EQUITY WITH AND WITHOUT FLOTATION. Jarett & Sons's common stock currently trades at $30.00 a share. It is expected to pay an annual dividend of $1.00 a share at the end

of the year (D, = $1.00), and the constant growth rate is 4% a year.

1. What is the company's cost of common equity if all of its equity comes from retained earnings?
2. If the company issued new stock, it would incur a 10% flotation cost. What would be the cost of equity from new stock?