If our company's bank loan has a 12 interest rate, what is our effective, after-tax interest cost? Assume the tax rate = 38%
If our preferred stock is paying a contractual $1.85 annual dividend and has current market price of $13.50, what is our cost of preferred stock?
A company pays a common stock dividend of $1.96. The stock's current price is 447.50 per share. Compute the cost of common equity.
The return on long-term US government securities (30 year Treasuries) = 5.25%. The projected 15-year average return of S&P 500 stocks is 6.05%. The stock we wish to invest in has a "beta" of 1.065. What does the CAPM formula say our cost of equity is? How risky is this stock as an investment?
To calculate the effective, after-tax interest cost of a bank loan, you need to subtract the tax savings from the interest expense. Here's how you can calculate it:
1. Calculate the tax savings: Multiply the bank loan interest rate by the tax rate (expressed as a decimal). In this case, it would be 12% * 0.38 = 4.56%.
2. Subtract the tax savings from the bank loan interest rate to get the effective, after-tax interest cost: 12% - 4.56% = 7.44%.
Therefore, the effective, after-tax interest cost of the bank loan with a 12% interest rate and a 38% tax rate is 7.44%.
For the cost of preferred stock, you can calculate it using the dividend yield formula:
Cost of preferred stock = Annual Dividend / Market Price
In this case, the annual dividend is $1.85 and the market price is $13.50. The cost of preferred stock would be $1.85 / $13.50, which is approximately 0.137, or 13.7%.
To calculate the cost of common equity, you can use the dividend yield formula:
Cost of common equity = Dividend / Current Stock Price
In this case, the dividend is $1.96 and the stock price is $447.50. The cost of common equity would be $1.96 / $447.50, which is approximately 0.00438, or 0.438%.
To calculate the cost of equity using the Capital Asset Pricing Model (CAPM), you need to use the following formula:
Cost of equity = Risk-Free Rate + Beta * Equity Risk Premium
In this case, the risk-free rate is 5.25% and the equity risk premium is the difference between the average return of S&P 500 stocks (6.05%) and the risk-free rate. Let's say it is 0.8%.
Substituting the values into the formula, the cost of equity = 5.25% + 1.065 * 0.8% = 5.25% + 0.852% = 6.102%.
Therefore, according to the CAPM formula, the cost of equity is 6.102%.
In terms of the investment risk, the stock's beta of 1.065 indicates that it is slightly more risky than the market on average. A beta of 1 means the stock moves in line with the market, while a beta greater than 1 indicates higher volatility. Therefore, with a beta of 1.065, this stock has slightly higher risk compared to the market.