1) The earnings, dividends, and the stock price of Shelby, Inc. are expected to
ID: 2716540 • Letter: 1
Question
1) The earnings, dividends, and the stock price of Shelby, Inc. are expected to grow at 7% per year in the future. Shelby’s common stock sells for $29.00 a share, its last dividend (D0) was $2.00. The company's marginal tax rate is 40%
a) Using the discounted cash flow approach, what is the cost of the equity?
b) If the firm’s bonds have a current yield to maturity of 12%, what would be its cost of debt capital? (ignore any floatation costs)
c) On the basis of the results of parts (a) and (b) , what would be your estimate of Shelby’s weighted average cost of capital if it projects using a mix of 60% equity and 40% debt to finance its operations?
2) A company’s 6% coupon rate, semiannual payment, $1000 par value matures in 30 years sells at a price of $815. The company’s marginal federal plus state tax rate is 40%. What would be the estimated after tax cost of debt to the company for the purpose of calculating the WACC?
3) Assume that the average firm in your company’s industry is expected to grow at a constant rate of 6% and the forward dividend yield (the dividend a year from now divided by today's price) is 7%. Your company is about as risky as the average firm in the industry, but has just successfully completed some R&D work that leads you to expect that its earnings and dividends will grow at a rate of 50% [D1 = D0 (1+g) = D0 x (1.50)) this year and 25% the following year, after which growth should return to the 6% industry average. If the last dividend paid (D0) was $1.00, what is the value per share of your firm’s stock?
a) What is the discount rate for stocks in this industry?
b) What are the projected dividends for years 1, 2 and 3?
c) What is the estimated value of the stock in year 2?
d) What is the estimated value of the stock today?
Explanation / Answer
1)
2)
Where,
n = Number of Coupon Payments = Number of Periods per Year × Maturity in Years
3)
a)discount rate in the industry is 6%
b)
c)
d)
cost of equity= (D1/P0)+g Where P0 is the price of the stock D1= estimated dividend for next period r = required rate of return g=growth rate D1 = (D0*(1+g)) (2*1.07) = $2.14 cost of equity= (2.14/29)+7% 14.38% cost of debt= 12(1-.4) 7.2 weighted average cost of capital 14.38*(0.6)+7.2*(0.4) 11.51%Related Questions
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