"Corporate Finance":Concepts and Basic Tools

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Questions 1:

When computing the weighted average cost of capital (WACC) and assuming a fixed-rate non-callable bond is currently selling above par value, the before-tax cost of debt is closest to the:

A、 coupon rate.

B、 yield to maturity.

C、 current yield.

Questions 2:

A company’s $100 par value preferred stock with a dividend rate of 9.5% per year is currently priced at $103.26 per share. The company’s earnings are expected to grow at an annual rate of 5% for the foreseeable future. The cost of the company’s preferred stock is closest to:

A 、9.5%.

B、 9.2%.

C、 9.7%.

View answer resolution

【Answer to question 1】B

【analysis】

B is correct. With a fixed-rate non-callable bond, the before-tax cost of debt is the bond’s yield to maturity.

A is incorrect because the coupon rate is higher than the yield-to-maturity based on the bond selling above par value.

C is incorrect because the current yield is the coupon divided by the bond price which does not equal the yield-to-maturity.

【Answer to question 2】B

【analysis】

B is correct. rp = Dp/Pp (or Dividend/Price) = ($100 × 0.095)/$103.26 = 9.2%.