Growth Company\'s current share price is $20.25 and it is expected to pay a $1.3
ID: 2807661 • Letter: G
Question
Growth Company's current share price is $20.25 and it is expected to pay a $1.30 dividend per share next year. After that, the firm's dividends are expected to grow at a rate of 4.2% per year a. What is an estimate of Growth Company's cost of equity? b. Growth Company also has preferred stock outstanding that pays a $1.85 per share fixed dividend. If this stock is currently priced at $28.25, what is Growth Company's cost of preferred stock? C. Growth Company has existing debt issued three years ago with a coupon rate of 6.2%. The firm just issued new debt at par with a coupon rate of 6.7%. What is Growth Company's cost of debt? d. Growth Company has 4.6 million common shares outstanding and 1.3 million preferred shares outstanding, and its equity has a total book value of $50.0 million. Its liabilities have a market value of $20.1 million. If Growth Company's common and preferred shares are priced as in parts (a) and (b), what is the market value of Growth Company's assets? e. Growth Company faces a 38% tax rate. Given the information in parts (a) through (d), and your answers to those problems, what is Growth Company's WACC? a. What is an estimate of Growth Company's cost of equity? The required return (cost of capital) of levered equity is %. (Round to two decimal places.)Explanation / Answer
.a. Cost of equity
Current share price=P0=$20.25
Next year’s dividend=D1=$1.30
Expected growth rate of dividend =g=4.2%=0.042
P0=D1/(R-g)
R=Required rate of return=cost of equity
R-g=D1/P0=1.3/20.25=0.064198
Cost of equity=R=0.064198+g=0.064198+0.042=0.106198
Cost of equity=0.106198=10.6% (rounded to one decimal)
.b Cost of Preferred Stock
Current price=$28.25
Dividend=$1.85
Return=1.85/28.25=0.065487
Cost of preferred stock=0.065487=6.5%(rounded to one decimal)
.c Cost of debt
Market rate of interest =cost of new debt issued at par(Before tax)=6.7%
Tax rate=38%
Cost of debt (after tax)=6.7*(1-0.38)=6.7*0.62=4.15%
.d Market value of assets
Market value of 4.6 million common shares=$(4.6*20.25)million=$93.15 million
Market value of preferred shares=$(1.3*28.25) million=$36.725 million
Market value of liabilities=$20.1 million
Market value of assets=(93.15+36.725+20.1)=$149.975 million
.e Calculation of WACC(Weighted Average Cost of Capital)
WACC=Weight of common stock* cost of common stock+ Weight of Preferred stock*cost of preferred stock+ Weight of debt* cost of debt
WACC=(93.15/149.975)*10.6+(36.725/149.975)*6.5+(20.1/149.975)*4.15
WACC=8.7%
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