Ameristar, Inc. can obtain funds for future investments through retained earnings, new issues of common stock, issuance of debt, and issuance of preferred stock. The Board of Directors believe an appropriate capital structure is one where funds are acquired in the following mix: 30% debt, 10% preferred stock, and 60% common stock. New issuance or flotation costs for the issuance of new securities amount to 3% for debt, 5% for preferred stock, and 10% for common stock. Ameristar has $180 million available in retained earnings and has a marginal tax rate of 33%.

If Ameristar sells a new issue of bonds that pay a 8.5% semi-annual coupon and mature in 20 years, these bonds can be sold for $1,242.68. If Ameristar sells a new issue of preferred stock that pay dividends at the rate of 8% with a par value of $50.00, these shares of preferred stock can be priced at $25.72. If Ameristar sells a new issue of common stock the dividends paid are expected to be the same as those dividends of the current common stock outstanding. Ameristar just paid a dividend on shares of their common stock of $1.65 (D₀=$1.65) and in the recent past dividends have grown at a rate of 7%. This growth rate is expected to continue into the foreseeable future for common stock. Common stock currently sells for $15.12 a share.

What is Ameristar's after-tax cost of a new issue of debt?

1. 4.25%

2. 4.44%

3. 6.87%

4. 6.63%

5. 4.60%

Answer rating: 100% (QA)

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