Two years ago Clark Company issued a 10-year, 12% annual coupon bond at its par
ID: 2724643 • Letter: T
Question
Two years ago Clark Company issued a 10-year, 12% annual coupon bond at its par value of $1,000. Currently, the bond can be called in 4 years at a price of $1,060 and it sells for $1,100. The company has a risk premium of 3.5%, a beta of 1.6, and the average return on the market is 13%. Clark Company just paid a dividend of $3.00 and the dividends are expected to grow at 7% per year. If you read in the wall street journal that 30- day T-bills are currently yielding 5.5% and 30-year T-Bonds are yielding 10%, what is the required rate of return on this stock if the stock is selling for $23.00 per share? Use the average of the 3 estimates approach. If Clark Company decides to issue new stock with flotation cost of 2%, what is the cost of new common stock?Explanation / Answer
Bond yield method
Bond yield with approximation method =120+(1060-1100)/4
1060+1100/2
=10.18%
ke =10.18+3.5
=13.68%
CAPM model
Ke =.10+1.6*(.13-.10)
=14.8%
DCF approach
Ke =3(1+.07)/23 +.07
=20.96%
Average Ke= (13.68+14.8+20.96)3
=16.48%
New equity cost =16.48(1+.02)
=16.81%
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