Calculate Allied’s cost of debt

Calculate Allied’s cost of debt

Financial Management Project Question

SHOW ALL WORKINGS

The
following balance sheet extract relates to the Allied Insurance Company

Bonds
Payable $1,000,000

Preferred
Stock $2,000,000

Common
Stock $3,000,000

Additional
Information:

1.
The bonds are 8%, annual coupon
bonds, with 9 years to maturity and are currently selling for 90% of par.

2.
The company’s common shares
which have a book value of $25 per share are currently selling at $20 per
share.

3.
The preferred shares are 5%
preferred shares with a book value of $100 per share. These shares are currently selling at $80 per
share.

4.
The company has an equity beta
of 1.35 and the current Treasury bill rate is 3.0%. The market risk premium is 1.5%

5.
The company’s tax rate is 30%.

A.
Calculate Allied’s cost of
debt. (4 points)

B.
Calculate Allied’s cost of
equity. (3 points)

C.
Calculate Allied’s cost of
preferred shares (3 points)

D.
Estimate Allied’s market value
weighted average cost of capital. (3
points
)

E.
Explain why the cost of debt is
cheaper than the cost of equity. (2
points)


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