12/7/2017 Cost Of Debt And Preferred Stock

Cost Of Debt And Preferred Stock

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Chapter One Chapter Two Chapter Three Chapter Four Chapter Five
5.1 Risk Management And Options
5.2.1 Introduction To Cost Of Capital
5.2 Cost Of Capital
5.2.2 Cost Of Equity
5.3 Financial Leverage And Capital
5.2.3 Cost Of Debt And Preferred Stock
Structure Policy
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5.2.4 Weighted Average Cost Of Capital (WACC)
5.4 Dividends Topics Reference Advisors Markets Simulator Academy
5.2.5 Divisional And Project Costs of Capital
5.5 Raising Capital
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Recall from Section 5 that companies sometimes finance their operations through debt in the form
of bonds because bonds provide more flexible borrowing terms than banks. How much do Frequently Asked Questions
companies pay for this debt? Do real estate agents need a degree?

Compared to cost of equity, cost of debt is fairly straightforward to calculate. The rate applied to What do real estate attorneys do?
determine the cost of debt (Rd) should be the current market rate the company is paying on its debt.
How do you calculate R-squared in Excel?
If the company is not paying market rates, an appropriate market rate payable by the company
should be estimated. The Di erences Between 401(k) and 403(b) P

Calculating the Cost of Debt

Because companies benefit from the tax deductions available on interest paid, the net cost of the
debt is actually the interest paid less the tax savings resulting from the tax-deductible interest
payment.

The a er-tax cost of debt can be calculated as follows:

A er-tax cost of debt = Rd (1- Trading Center

tc)
Note: Rd represents the cost to issue new
debt, not the cost of the firm\'s existing
debt.

Example: Cost of Debt

Newco plans to issue debt at a 7% interest rate. Newco's total (both federal and state) tax rate is 40%.
What is Newco's cost of debt?
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Answer: dollars...

Rd (1-tc) = 7% (1-0.40) = 4.2%

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Calculating the Cost of Preferred Stock

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12/7/2017 Cost Of Debt And Preferred Stock

As we discussed in section 6 of this walkthrough, preferred stocks straddle the line between stocks
and bonds. Technically, they are equity securities, but they share many characteristics with debt
instruments. Preferreds are issued with a fixed par value and pay dividends based on a percentage of
that par at a fixed rate.

Cost of preferred stock (Rps) can be calculated as follows:

Rps = Dps/Pnet
where:
Dps = preferred
dividends
Pnet = net
issuing price
Example: Cost of Preferred Stock
Assume Newco's preferred stock pays a dividend of $2 per share and sells for $100 per share. If the
cost to Newco to issue new shares is 4%, what is Newco's cost of preferred stock?

Answer:
Rps = Dps/Pnet = $2/$100(1-0.04) = 2.1%

For more on this subject, read Prefer Dividends? Why Not Look At Preferred Stock?

Next, we'll take a look at the weighted average cost of capital, a calculation that will put our formulas
for both the cost of equity and the cost of debt to work.

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Next: Weighted Average Cost Of Capital (WACC)

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