The information below applies to the remaining problems. Rollins Corporation tar

Question

The information below applies to the remaining problems.

Rollins Corporation targets a capital structure of 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sell for $1,000. The firm could sell, at par, $100 preferred stock, which pays a 12 percent of par annual dividend, but flotation costs will be 5 percent. Rollins' beta is 1.2, the risk-free rate is 10 percent, and the market risk premium is 5 percent. Rollins is a constant growth firm, which just paid a dividend of $2.00, sells for $27.00 per share, and has a growth rate of 8 percent. The firm's policy is to use a risk premium of 4 percentage points when using the bond-yield-plus-risk-premium method to find Rs. The firm expects net income to be $1 million, and its dividend payout ratio is 40 percent. Flotation costs on new common stock total 10 percent, and the firm's marginal tax rate is 40 percent.

1. What is Rollins' cost of preferred stock (including flotation costs)?

a. 10.0%                  b. 11.0%

c. 12.0%                  d. 12.6%

e. 13.2%

2. What is Rollins' cost of retained earnings using the CAPM approach?

a. 13.6%                  b. 14.1%

c. 16.0%                  d. 16.6%

e. 16.9%

3. What is Rollins' cost of retained earnings using the bond-yield-plus-risk-premium approach?

a. 13.6%                  b. 14.1%

c. 16.0%                  d. 16.6%

e. 16.9%

4. What is Rollins' WACC?

a. 13.6%                  b. 14.1%

c. 16.0%                  d. 16.6%

e. 16.9%

Explanation / Answer

1)=Preference dividend/preferred stock*(1-flotation)
=(12%*1000)/(100*(1-5%))
=12.6%
it is option D
2)=Risk free+(beta*market preminum)
=10%+(1.2*5%)=16%
option C
3)bond yiled can be found using rate formuale in excle
==12%+4%=16%
OptionC
4)WACC=(Wt of debt*cost of debt)+(wt of preferred stock*cost of preferred)+(wt of equity*cost of equity)
=(12.6%*20%)+(16%*60%)+(12%*(1-40%)*20%)
=13.6%
option A

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