Question

Bay beach industries wants to maintain their capital structure of 40% debt and 60% equity. the firm's tax rate is 34%. the firm can issue the following securities to finance the investments: bonds: mortgage bonds can be issued at a pre-tax cost of 7.7 percent. debentures can be issued at a pre-tax cost of 7.7 percent. common equity: some retained earnings will be available for investment. in addition, new common stock can be issued at the market price of $50. flotation costs will be $4 per share. the recent common stock dividend was $7.58. dividends are expected to grow at 5% in the future. what is the cost of capital using mortgage bonds and internal equity?

Answer 1

To determine the cost of capital using mortgage bonds and internal equity, calculate the cost of each component and apply the weights according to the desired capital structure.

Step-by-step explanation:

To determine the cost of capital using mortgage bonds and internal equity, we need to calculate the cost of each component and then apply the weights according to the desired capital structure.

The cost of mortgage bonds can be found using the pre-tax cost of 7.7 percent. The after-tax cost of debt can be calculated by multiplying the pre-tax cost by (1 - tax rate). For debentures, the same process can be followed.

For internal equity, we need to calculate the cost of retained earnings and the cost of issuing new common stock. The cost of retained earnings is the opportunity cost of using the funds for other investments.

The cost of issuing new common stock includes the market price, flotation costs, and the expected growth rate of dividends. After calculating the cost of each component, we can use the weights (40% debt and 60% equity) to find the overall cost of capital.