Question

Company A common stock 1,800,000 shares, B= 1.5. Company A just paid a dividend of $.80, with expected dividends growth at 5% per year. The ERM is 12%, and TB =yielding 3.5%. The most recent stock price for Company A is $61.

B= beta, ERM = expected return on market, TB = Treasury Bills

Company A has 40,000 semi-annual-coupon bonds with CR= 7%, PV= $1000, CPQ=119.80%; the bonds have 25 years to maturity.

It also has 100,000 shares of 4% dividend preferred stock with a current price of $78, and a PV= $100.

CR = Coupon Rate PV = par value, CPQ= current price quote

Ignore all floatation costs. The tax rate is 40%.

Calculate the cost of equity using the DCF method.

Calculate the cost of equity using the CAPM method.

Calculate the before-tax cost of debt.

Calculate the cost of preferred stock.

What are the percentages of total value of Floyd in equity, debt and preferred stock?

What is Company A’s WACC, assuming cost of equity as average of (a) and (b)?

Answer 1

1)

Cost of equity using DCF method:

Cost of equity = (D1 / Share price) + grwoth rate

Cost of equity = [ 0.8 ( 1.05) / 61] + 0.05

Cost of equity = 0.06377 or 6.377%

2)

Cost of equity using CAPM method = risk free rate + beta ( market risk prmium)

Cost of equity = 0.035 + 1.5 ( 0.12)

Cost of equity = 0.215 or 21.5%

3)

Coupon payment = 0.07 * 1000 = 70 / 2 = 35

Price = 119.8% of 1000 = 1,198

Number of periods = 25 * 2 = 50

Before tax cost of debt using financial calculator = 5.53%

Keys to use in a financial calculator: 2nd I/Y 2, FV = 1000, PV = -1198, PMT = 35, N = 50, CPT I/Y

4)

Annual dividend = 0.04 * 100 = 4

Cost of preferred shares = Annual dividend / Preferred shares price

Cost of preferred shares = 4 / 78

Cost of preferred shares = 0.051282 or 5.1282%

5)

Market value of common stock = 1,800,000 * 61 = 109,800,000

Market value of debt = 40,000 * 1,198 = 47,920,000

Market value of preferred shares = 100,000 * 78 = 7,800,000

Total mrket value of capital structure = 109,800,000 + 47,920,000 + 7,800,000 = 165,520,000

Percentage of common stock = ( 109,800,000 / 165,520,000 ) * 100

Percentage of common stock = 66.3364%

Percentage of debt = ( 47,920,000 / 165,520,000 ) * 100

Percentage of debt = 28.9512%

Percentage of preferred stock = ( 7,800,000 /  165,520,000 ) * 100

Percentage of preferred stock = 4.7124%

6)

Average cost of equity = ( 0.06377 + 0.215 ) / 2

Average cost of equity = 0.139385 or 13.9385%

WACC = weight of equity * Cost of equity + weight of debt * cost of debt * ( 1 - tax) + weight of preferred shares * cost of preferred shares

WACC = 0.663364 * 0.139385 + 0.289512 * 0.0553 * ( 1 - 0.4 ) + 0.047124 * 0.051282

WACC = 0.092463 + 0.009606 + 0.002417

WACC = 0.104486 or 10.4486%