The problem provides information about Skyworth's financing plans, including issuing bonds and common stock. It asks to calculate: - The net proceed from issuing the bond. - The firm's before-tax cost of debt. - The firm's after-tax cost of debt. - The net proceed from issuing common stock. - The firm's cost of a new issue of common stock. - The weighted average cost of capital. - The firm's cost of retained earnings.

1. Problem Description

The problem provides information about Skyworth's financing plans, including issuing bonds and common stock. It asks to calculate:

- The net proceed from issuing the bond.

- The firm's before-tax cost of debt.

- The firm's after-tax cost of debt.

- The net proceed from issuing common stock.

- The firm's cost of a new issue of common stock.

- The weighted average cost of capital.

- The firm's cost of retained earnings.

2. Solution Steps

a. Net proceed from issuing bond:

The company sold the bond at $965 and paid$5 as flotation cost.

Net proceed = Selling price - Flotation cost

Net proceed = $965 -$5 = $960

b. The firm's before-tax cost of debt:

The coupon rate is 7% on a $1000 bond, so the annual coupon payment is$1000 * 0.07 = $

7

0. The bond has 8 years to maturity and was sold for $965 with $5 flotation costs, so the net proceeds are $

9

6

0. We need to find the yield to maturity (YTM) which is the before-tax cost of debt. Since we don't have a financial calculator available to solve for YTM exactly, we will approximate.

Using the approximation formula:

$YTM \approx \frac{Coupon\ Payment + \frac{Face\ Value - Net\ Proceeds}{Years\ to\ Maturity}}{\frac{Face\ Value + Net\ Proceeds}{2}}$

$YTM \approx \frac{70 + \frac{1000 - 960}{8}}{\frac{1000 + 960}{2}}$

$YTM \approx \frac{70 + \frac{40}{8}}{\frac{1960}{2}}$

$YTM \approx \frac{70 + 5}{980}$

$YTM \approx \frac{75}{980}$

$YTM \approx 0.07653$

YTM $\approx$ 7.65%

c. The firm's after-tax cost of debt:

After-tax cost of debt = Before-tax cost of debt * (1 - Tax rate)

After-tax cost of debt = 0.07653 * (1 - 0.36)

After-tax cost of debt = 0.07653 * 0.64

After-tax cost of debt = 0.049

After-tax cost of debt = 4.90%

d. The net proceed from issuing common stock:

The stock currently trades at $41 per share. Stock underpricing is$3 and flotation cost is $1.

5

0. Net proceed = Market Price - Underpricing - Flotation Cost

Net proceed = $41 -$3 - $1.50 =$36.50

e. The firm's cost of a new issue of common stock:

We use the Gordon Growth Model (Dividend Discount Model):

$Cost\ of\ Equity = \frac{D_1}{P_0} + g$

Where $D_1$ is the expected dividend next year, $P_0$ is the net proceed from issuing common stock, and $g$ is the growth rate.

$Cost\ of\ Equity = \frac{2.4}{36.50} + 0.06$

$Cost\ of\ Equity = 0.06575 + 0.06$

$Cost\ of\ Equity = 0.12575$

$Cost\ of\ Equity = 12.58$

f. The weighted average cost of capital (WACC):

Equity = 0.63, Debt = 1 - 0.63 = 0.37

WACC = (Weight of Equity * Cost of Equity) + (Weight of Debt * After-tax cost of debt)

WACC = (0.63 * 0.12575) + (0.37 * 0.049)

WACC = 0.07922 + 0.01813

WACC = 0.09735

WACC = 9.74%

g. The firm's cost of retained earnings:

Since the company uses the DDM approach for determining the cost of new issuance equity, the cost of retained earnings will be calculated using the same model, but using the current stock price instead of the net proceeds from a new issue.

$Cost\ of\ Retained\ Earnings = \frac{D_1}{P_0} + g$

Where $D_1$ is the expected dividend next year, $P_0$ is the current stock price, and $g$ is the growth rate.

$Cost\ of\ Retained\ Earnings = \frac{2.4}{41} + 0.06$

$Cost\ of\ Retained\ Earnings = 0.05854 + 0.06$

$Cost\ of\ Retained\ Earnings = 0.11854$

$Cost\ of\ Retained\ Earnings = 11.85$

3. Final Answer

The net proceed from issuing bond: $960

The firm's before-tax cost of debt is: 7.65%

The firm's after-tax cost of debt is: 4.90%

The net proceed from issuing common stock: $36.50

The firm's cost of a new issue of common stock is: 12.58%

The weighted average cost of capital is: 9.74%

The firm's cost of retained earnings is: 11.85%