Question

Growth​ Company's current share price is $20.20 and it is expected to pay a $1.00 dividend per share next year. After​ that, the​ firm's dividends are expected to grow at a rate of 3.6%

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 $2.30 per share fixed dividend. If this stock is currently priced at $28.15​, what is Growth​Company's cost of preferred​ stock?

c. Growth Company has existing debt issued three years ago with a coupon rate of 6.5%. The firm just issued new debt at par with a coupon rate of 6.1%. What is Growth​ Company's cost of​ debt?

d. Growth Company has 5.5 million common shares outstanding and 1.4 million preferred shares​ outstanding, and its equity has a total book value of $50.0 million. Its liabilities have a market value of $20.2 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 35% tax rate. Given the information in parts ​(a​) through ​(d​), and your answers to those​ problems, what is Growth​ Company's WACC?

​Note: Assume that the firm will always be able to utilize its full interest tax shield.

Answer 1

a]	Cost of equity under the constant dividend growth model = Next expected dividend/Current price+Growth rate = 1/20.20+0.036 =	8.55%
b]	Cost of preferred stock = Preferred dividend/Current price = 2.30/28.15 =	8.17%
c]	Cost of debt = Cost of new debt*(1-t) = 6.10%*(1-35%) =	3.97%
d]	Component of capital	Market Value       [$ million]
	Common equity = 5.5m*$20.20 =	$                   111.10
	Preferred stock = 1.4*$28.15 =	$                     39.41
	Debt [MV of liabilities as given]	$                     20.20
	Total	$                   170.71
	MV of company's assets = MV of equity+MV of liabilities =	$                   170.71
e]	CALCULATION OF WACC:
	Component of capital	Market Value       [$ million]	Weight	Component Cost	WACC
	Common equity = 5.5m*$20.20 =	$                   111.10	65.08%	8.55%	5.56%
	Preferred stock = 1.4*$28.15 =	$                     39.41	23.09%	8.17%	1.89%
	Debt [MV of liabilities as given]	$                     20.20	11.83%	3.97%	0.47%
	Total	$                   170.71	100.00%		7.92%
	WACC = 7.92%