. Rollins Corporation has a target capital structure is 20 percent debt, 20 perc

Question

. Rollins Corporation has a target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 10 percent coupon, paid semiannually, a current maturity of 20 years, par value of $1,000, and sell for $849.54. The firm could sell, at par, $100 preferred stock, which pays a $12 annual dividend. Rollins is a constant growth firm which just paid a dividend of $2.00, sells for $27.00 per share, and has a growth rate of 8 percent. Flotation costs on new common stock total 10 percent, and the firm's marginal tax rate is 40 percent.

a) What is Rollins' cost of debt?

b) What is Rollins' cost of preferred stock?

c) What is the firm's cost of retained earnings?

d) What is the cost of new equity of the firm?

Explanation / Answer

a) Calculating the cost of debt using Exel.

The formula is RATE(nper, pmt, pv, [fv], [type], [guess]).

Here
nper=number of periods=40=20 years semiannually
pmt= coupon payment to be made=.1x1000/2 = 50
pv = market price of bond
fv = par value of bond

Rate comes out to 6%

After tax cost of debt = 6% x (1 - Tax Rate) = 6%x0.6 = 3.6%

b) Cost of Preferred Stock = Dividend/Par Value = 12/100 = 12%

c) Cost of Retained Earnings = D1/P0 + g
Here D1 = 2 x 1.08 = 2.16
P0 = 27
g = 8%
Cost of Retained Earnings = 2.16/27 + 0.08 = 0.16 = 16%

d) Cost of Retained Earnings = D1/[P0*(1-F)] + g
Here D1 = 2 x 1.08 = 2.16
P0 = 27
g = 8%
Cost of Retained Earnings = 2.16/[27*(1-0.1)] + 0.08 = 0.1689 = 16.89%

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