In: Finance
WACC Estimation The following table gives the balance sheet for Travellers Inn Inc. (TII), a company that was formed by merging a number of regional motel chains.
The following facts also apply to TII:
Assume that you were recently hired by TII as a financial analyst and that your boss, the treasurer, has asked you to estimate the company's WACC under the assumption that no new equity will be issued. Your cost of capital should be appropriate for use in evaluating projects that are in the same risk class as the assets TII now operates.
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You have asked a question with multiple sub parts. I have addressed the first four of them. Please post the balance sub parts separately.
Part (a)
Market value of debt = D = -PV (Rate,Nper, PMT, FV) = - PV (12%/2, 20 x 2, 9% x 30, 30) = $ 43.54 million
Price of a preferred stock, PS = Anual dividend / Yield = 4 x 2/12% = 66.67
Market value of preferred stock = S = Price x Number = 66.67 x 5 million / Par value = 66.67 x 5 million / 100 = $ 3.33 million
Market value of equity, E = Price x Number = 20 x 4 = $ 80 million
Hence, total capital = C = D + S + E = 43.54 + 3.33 + 80 = $ 126.88
Weight
Long-term debt = D / C = 43.54 / 126.88 = 34.32%
Preferred stock = S / C = 3.33 / 126.88 = 2.63%
Common stock = E /C = 80 / 126.88 = 63.05%
Part (b)
What is the required return on long-term debt? Round your answer to two decimal places.
This should be same the YTM of the new debt, rd = 12.00%
Part (c) What is the required return on preferred stock? Do not round intermediate calculations. Round your answer to two decimal places.
The required return = Annual dividend / Price net of flotaton cost = 4 x 2 / [66.67 x (1 - 3%)] = 12.37%
Part (d)
Using the DCF model and the retention growth model for g, what is the required return on stock? Do not round intermediate calculations. Round your answers to two decimal places.
Required return on stock = D0 x (1 + g) / P0 + g = 1 x (1 + g) / 20 + g
Retention Growth Model
Retention ratio, RR = 1 - payout nratio = 1 - D0 / EPS0 = 1 - 1 / 2 = 50%
Hence, the estimate of g using retention growth model = RR x ROE0 = 50% x 28% = 14%
Hence, required return on stock = 1 x (1 + 14%) / 20 + 14% = 19.70%
Lowest analyst g = 10%;
Hence, required return on stock = 1 x (1 + 10%) / 20 + 10% = 15.50%
Highest analyst g = 15%
Hence, required return on stock = 1 x (1 + 15%) / 20 + 15% = 20.75%
Hence,
Retention growth model | Lowest analyst g | Highest analyst g | |
Estimate of g | 14% | 10% | 15% |
Required return on stock | 19.70% | 15.50% | 20.75% |