0 million shares and 200,000 bonds outstanding at par value $15,000. In addition, it has $500 million in short-term debt from bank. The target capital structure ratio is 70 percent equity, 20 percent long-term debt, and 10 percent short-term debt. The current capital structure has temporarily moved slightly away from the target ratio. The company’s shares currently trade at $50 with a beta of 1.30. The book value of the shares is $45. The annual coupon rate of the bonds is 10 percent, they trade at 105 percent of par, and they will mature in seven years. Interest on the short-term debt is 10 percent. The current yield on ten-year government bonds is 7 percent. The market risk is 15 percent. The corporate tax rate applicable is expected to be 25 percent.

0 million shares and 200,000 bonds outstanding at par value $15,000. In addition, it has $500 million in short-term debt from bank. The target capital structure ratio is 70 percent equity, 20 percent long-term debt, and 10 percent short-term debt. The current capital structure has temporarily moved slightly away from the target ratio. The company’s shares currently trade at $50 with a beta of 1.30. The book value of the shares is $45. The annual coupon rate of the bonds is 10 percent, they trade at 105 percent of par, and they will mature in seven years. Interest on the short-term debt is 10 percent. The current yield on ten-year government bonds is 7 percent. The market risk is 15 percent. The corporate tax rate applicable is expected to be 25 percent.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter15: Dividend Policy

Section: Chapter Questions

Problem 4P

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A company is all equity financed with 18,000 shares outstanding and each share sells for $22. The EBIT of the company is $50,000. The company is debating of converting into a 40% debt capital structure, with 6% interest per annum. The cost of capital is currently 10%. Ignore taxes. You are required to answer the following: (d) What is the cost of equity in the levered company? (e) What is the cost of capital of the levered company?
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