Assume that B (in Problem ) is $3 million and S is $7 million. The bonds have a 14 percent yield to

QUESTION

Assume that B (in Problem ) is $3 million and S is $7 million. The bonds have a 14 percent yield to maturity, and the stock is expected to pay $500,000 in dividends this year. The growth rate of dividends has been 11 percent and is expected to continue at the same rate. Find the cost of capital if the corporation tax rate on income is 40 percent.Problem:Zapata Enterprises is financed by two sources of funds: bonds and common stock. The cost of capital for funds provided by bonds is ki, and keis the cost of capital for equity funds. The capital structure consists of B dollars worth of bonds and S dollars worth of stock, where the amounts represent market values. Compute the overall weighted average of cost of capital, ko.
Total bond = 3,000,000 Total equity/stock = 7,000,000 YTM of bond = 14% Dividend expected = 500,000 Dividend growth rate = 11%, Tax rate = 40% First step is to calculate the cost of equity = ke = (D1/Po)+ g = (No. of shares * Divdend per share / no. of share * price per share) + growth rate of dividend = (Total dividend/total stock) + growth rate of dividend = (500,000/7,000,000) + 11% = .0714 + .11 = .1814 = 18.14% so cost of equity is 18.14% Cost of capita (Ko) = Kd (1-T) * Weight of debt + Ke * Weight of equity Kd = 14%, T

= 40% Weight of debt = Debt/(Debt + Equity) = 3/(3+7) = 3/10 = 0.3 Weight of equity =Equity/(Debt + Equity) = 7/10 = 0.7 So equating the values in the below expression: Cost of capita (Ko) = Kd (1-T) * Weight of debt + Ke * Weight of equity or, Ko = 14% *

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