[Solved]Explain why the cost of debt is cheaper than the cost of equity.

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[Solved]Explain why the cost of debt is cheaper than the cost of equity.

The following balance sheet extract relates to the Allied Insurance Company negotiate

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%.

5. The company’s tax rate is 30%.

A. Calculate Allied’s cost of debt.

B. Calculate Allied’s cost of equity.

C. Calculate Allied’s cost of preferred shares

D. Estimate Allied’s market value weighted average cost of capital.

E. Explain why the cost of debt is cheaper than the cost of equity.