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 for a bank loan, you can follow these steps:
1. Determine the interest expense: Multiply the loan amount by the interest rate. For example, if the loan amount is $100,000 and the interest rate is 12%, the interest expense would be $12,000 per year.
2. Calculate the tax shield: Multiply the interest expense by the tax rate. In this case, the tax rate is 38%, so the tax shield would be $4,560 ($12,000 x 0.38).
3. Subtract the tax shield from the interest expense: Subtract the tax shield from the interest expense to find the effective after-tax interest cost. In this example, the effective after-tax interest cost would be $7,440 ($12,000 - $4,560).
To determine the cost of preferred stock, you can use the formula:
Cost of Preferred Stock = Dividend Payment / Market Price
So, for the given scenario:
Cost of Preferred Stock = $1.85 / $13.50
The cost of preferred stock would be approximately 0.137, or 13.7%.
To calculate the cost of common equity, you can use the formula:
Cost of Common Equity = Dividend / Stock Price + Growth Rate of Dividends
In this case:
Cost of Common Equity = $1.96 / $447.50 + 0 (assuming no growth rate mentioned)
The cost of common equity would be approximately 0.004, or 0.4%.
To determine the cost of equity using the Capital Asset Pricing Model (CAPM), follow these steps:
1. Find the risk-free rate: Use the return on long-term US government securities (30-year Treasuries), which is given as 5.25%.
2. Calculate the equity risk premium: Subtract the risk-free rate from the projected average return of S&P 500 stocks. In this case, the equity risk premium would be 6.05% - 5.25% = 0.8%.
3. Multiply the equity risk premium by the stock's beta: Multiply the equity risk premium by the beta of the stock to find the stock's expected excess return. For instance, if the beta is 1.065, the expected excess return would be 0.008 x 1.065 = 0.00852 or 0.852%.
4. Add the risk-free rate to the expected excess return: Sum the risk-free rate and the expected excess return to determine the cost of equity. In this example, the cost of equity would be 5.25% + 0.852% = 6.102% or 6.10%.
The riskiness of the stock as an investment can be inferred from its beta. A beta greater than 1 suggests that the stock is more volatile than the overall market, while a beta less than 1 indicates less volatility. In this case, the stock's beta of 1.065 suggests that it is slightly more risky than the market.