Given the following data: Tax rate of 35% Bonds: 12% semiannual coupon with 15 y

Question

Given the following data: Tax rate of 35%

Bonds: 12% semiannual coupon with 15 year maturity. Current price is $1153.72, and no flotation cost.

Preferred Stock: $100 par value with a 10% quarterly dividend. Its current price is $113.10.

Common Stock: Current price is $45.00 per share. Do= $4.20, excepted dividend growth is 6%, Beta= 1.2.

T-Bond Yield (rRF)=6%, Market Risk Premium (rM-rRF)=9%, risk premium=4%

Retain Earnings for next year= $300,000

Floatation cost for new common stock=6.5%

Capital Structure: Debt= 25% ; Preferred Stock= 10% ; Common Stock= 65%

a. What is the interest rate on the firms debt(rd) and what is the after tax cost of debt?

b. What is the firms cost of preferred stock (rp)?

c. What is the firms cost of retained earnings using the CAPM, DCF, and Bond-Yield-Plus-a-Risk-Premium approaches? What is your final eatimate of rs?

d. At what breakpoint would the firm be forced to issue new equity?

e. What is the firms cost of newly issued common equity (re)?

f. What is the firms WACC if it uses only retained earnings?

g. What will be the WACC if the firm has to issue new equity?

Explanation / Answer

a.
rd = ((coupon rate/2 * 1000)/current price)^2 - 1
= ((12%/2 * 1000)/1153.72)^2 - 1
= 10.6716%

after tax cost of debt = pretax cost of debt * (1-tax rate)
= 10.6716% * (1-35%)
= 6.9365%

b.
rp = (% dividend * par value)/current price
= (10% * 100)/113.10
= 8.8417%

c.
by CAPM
rs = rRF + beta*(rM - rRF)
= 6% + 1.2*9%
= 16.8%

by DCF
rs = (D0*(1+g)/P) + g
= ((4.2*(1+6%)/45) + 6%
=15.8933%

by bond yield plus risk approach
rs = rRF + risk premium
= 6% + 4%
= 10%

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