Question

The capital structure of Global Motors is as follows: 55% common stock; 10% preferred stock; and 35% long term debt. The expected risk premium of Global Motor’s stock vs. US long-term Govt bonds is 7.5%. The 20-year US long-term Govt. default-free bond yield is 6.0%. The company’s credit rating is A- and the credit spread for 20-year A- corporate debt is 1.0%. Global Motor’s tax rate is 30%. The company recently issued preferred stock with a par value = $60/share that pays a 12% dividend yield. Issuance costs were 2.5% of par

Answer 1

The calculation of Global Motors' capital costs involves adding risk premiums to government bond yields for equity, adjusting dividend yields for issuance costs in preferred stock, and incorporating credit spreads and tax benefits for long-term debt.

Step-by-step explanation:

The task at hand involves analyzing the capital structure of a company, Global Motors, and determining the various costs associated with common stock, preferred stock, and long-term debt, given certain parameters including market yields, risk premiums, credit spreads, and tax rates. For common stock, we use the risk premium added to the government bond yield to estimate the expected return. For preferred stock, the given dividend yield is adjusted for issuance costs. For long-term debt, the yield on A- corporate debt is found by adding the credit spread to the government bond yield and then adjusting for the tax shield that debt provides.

An illustration of this process would involve taking the 6.0% yield of the 20-year US bond as the risk-free rate and adding the 7.5% risk premium for Global Motors' stock, which gives us an expected return of 13.5% for the equity. The cost of preferred stock would be slightly higher than the 12% dividend yield due to the 2.5% issuance costs.