Finance Expert Help ASAP You have the following information for the company “Spy

Question

Finance Expert Help ASAP

You have the following information for the company “Spy”. The “beta” coefficient for “Spy” is 1.05 based on the past information. The 5-year average of 30-day T-bill rate is 2%, the average market return of (say, S&P 500 index) in the same period is 14.5%. Answer the following questions:

a) What is the required rate of return for “Spy”? Why do we call it “required” rate of return?

b) Suppose the current dividend for “Spy” is $3.12 per share with possible expected growth rate as 7% per year from now on, what is your assessment for the value of Spy’s stock?

c) Suppose without using the information of “beta”, the current market price for the “Spy’s stock is $26.50 per share. Let the capital market be efficient as ideally assumed. That is, the current stock price is equal to the stock’s present value. What is the required rate of return for this stock now if the information in (b) still applies? What is the “beta” associated with this stock now?

d) “Spy” has the following capital structure: the firm issued 6 million shares of common stock with the stock price given in c) and dividend in b), the firm also issued 2 million shares of preferred stock with $1.09 preferred dividend per share, and currently, “Spy” has $90 million in debts with interest rate as 6%. Suppose the current preferred stock price is $6.72 per share. The corporate tax rate is 30% and the common stock price is as given in c), what is the (after-tax) weighted average cost of capital (after tax) for “Spy”?

e) What is meaning of “Weighted Average Cost of Capital (after tax)”? Why do we usually apply it as the discount rate for expected future cash flows in capital budgeting decisions?

Thank you for your assistance

Explanation / Answer

a) required rate of return= riskfree rate+Beta(risk premium) 2%+1.05*(14%-2%) 14.60% This is called required rate of return because the investor expects this return to take the risk of investing in the firm, this is investors expected rate of return b) D0(current dividend) 3.12 D1(next year dividend) 3.34 (3.12*1.07) value of stock= D1/required return-growth rate 3.34/(14.6%-7%) 43.95 $ c) current market price 26.5 required rate of return=3.34/26.5 12.60% Beta = 12.6/14.6 0.86 d) shares 6 million stock price 26.5 Dividend 3.34 Cost of common stock 12.60% (3.34/26.5) preferred stock 2 Million preferred DPS 1.09 Debt at 6% 90 million preferred stock price 6.72 Cost of preferred stock 16.22% Tax 30% after tax cost of debt 4.20% 6%(1-.3) value weights Cost weight*cost common stock(6*26.5) 159 0.606 12.60% 0.0763 Preferred stock(2*6.72) 13.44 0.051 16.22% 0.0083 Debt 90 0.343 4.20% 0.0144 262.44 1 Weighted average cost of capital 9.90% WACC takes into account the entires capital structure into account hence it is used for capital budgeting decisions

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