You have following information about the company R.S. Green: The company has 250

Question

You have following information about the company R.S. Green: The company has 250,000 shares of common stock outstanding at a market price of $28 a share. Next year’s annual dividend is expected to be $1.55 a share. The dividend growth rate is 2%. The company also has 7,500 bonds outstanding with a face value of $1000 per bond. The bonds carry a 7% coupon, pay interest semiannually, and mature in 7.5 years. The bonds are selling at 98% of face value. The corporate tax rate for the company is 34 percent. 1). What is WACC for the company? 2). The company want to raise 5 million in capital, but still maintain its current capital structure. Given that the flotation cost for common stock is 5%, and the floatation cost for bond is 3%, what is the true amount of capital that the company has to raise? 3). The company will invest newly raised capital in a project, which will generate annual cash inflows of 1.2 million for the next 5 years. What are the NPVs of the project before and after adjusted for floatation cost?

Explanation / Answer

Dividend = $1.55

growth rate = 2%

price = $28

cost of equity = D1/P0 + g

= $1.55*(1+0.02)/ 28 + 0.02

= 7.65%

cost of bond = [interest*(1- tax) + (R.v- F.v.)/2] / (R.v + F.v)/n]

= [$70(1-.34) + (980-1000)/2] / (980+1000)/7.5

= 13.71%

WACC = cost of equity * weight of equity + cost of debt* weight of debt

= 7.65* (0.25) + 13.71* 0.75

= 12.20%

True amount of capital to company = $5000000*0.25 *(1-0.05) + $5000000 * 0.75 * (1-.03)

= $4825000

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