Useless tool Co. Inc., has an aftertax cost of debt of 6 percent. With a tax rate of 33 percent, what can you assume the yield on the debt is?

8.95%

2. Addison Glass Company has a $1,000 par value bond outstanding with 25 years to maturity. The bond carries an annual interest payment of $88 and is currently selling for $925. Addison is in a 25 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 approximate yield to maturity (Formula 11-1) on the old issue and use this as the yield for the new issue.

b. Make the appropriate tax adjustment to determine the aftertax cost of debt.

a.	9.53%
b.	7.15%

3. Burger Queen can sell preferred stock for $70 with an estimated flotation cost of $2.50. It is anticipated the preferred stock will pay $6 per share in dividends.

a. Compute the cost of preferred stock for Burger Queen.

b. Do we need to make a tax adjustment for the issuing firm?

a.	8.89%
b.

4. The treasurer of BioScience, Inc., is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 2 percent less than that for preferred stock. Based on the following facts, is she correct?

Debt can be issued at a yield of 11 percent, and the corporate tax rate is 30 percent. Preferred stock will be priced at $50 and pays a dividend of $4.80. The flotation cost on the preferred stock is $2.10.

5. Business has been good for Keystone Control Systems, as indicated by the four-year growth in earnings per share. The earnings have grown from $1.00 to $1.63.

a. Use Appendix A at the back of the text to determine the compound annual rate of growth in earnings (n = 4).

b. Based on the growth rate determined in part a, project earnings for next year (E₁). Round to two places to the right of the decimal point.

c. Assume the dividend payout ratio is 40 percent. Compute D₁. Round to two places to the right of the decimal point.

d. The current price of the stock is $50. Using the growth rate (g) from part a and (D₁) from part c, compute Ke.

e. If the flotation cost is $3.75, compute the cost of new common stock (K_n).

a.
b.
c.
d.
e.