Use the following information for the next six questions: A firm has 2 million shares of...

Use the following information for the next six questions:

A firm has 2 million shares of common stock outstanding, currently selling at $60 per share.
It is expected to have EPS and dividends per share at the end of the current year in the amounts of $4 and $2.45, and a Return on Equity of 10%.
It also has $100 Million par value of debt on its books, which is currently selling at a 5% discount to par. The debt is 20-year debt with a 4% annual coupon rate.
The firm has ROE of 10% and a 25% marginal tax rate
The firm’s “regular” (non-adjusted) beta is 2.0, the current YTM on treasuries is 3%, and the market risk premium is 4%
The firm has a size beta of 0.20, a value beta of 0.50 and a liquidity beta of 0.15 -- historical returns on various subsets of firms are as follows:

Subset	Historical Average return
Small Firms	14%
Large Firm	10%
Value Firms	13%
Growth Firms	9.5%
Very Liquid firms	9%
Illiquid firms	13.5 %

What are the weights of debt and equity for the firm?
What is the cost of equity based on the Fama-French Model?
What is the cost of equity based on the Pastor-Stambaugh model?
What is the cost of equity based on the Gordon-Growth (i.e. constant growth) model?
What are the before and after-tax costs of debt?
What is the WACC for the firm using the Gordon-growth model’s cost of equity and the weights from question #22?

Solutions

Expert Solution

a) Number of shares = 2,000,000

Market value per share = $60

Market value of equity = $60*2,000,000 = $120,000,000

Face value of Debt on books = $100,000,000

Market value of Debt = 5% below par = $95,000,000

Market Value of Debt + Equity = $215,000,000

Weight of Debt = ($95,000,000/$215,000,000) = 44.2%

Weight of Equity = ($120,000,000/$215,000,000) = 55.8%

b) Given:

Risk free rate = 3%, Regular Beta = 2, Market Risk Premium = 4%

Size beta =0.2, Value Beta = 0.5

Cost of equity = R_f + Beta_regular*Market risk Premium + Beta_size*(Small-Big) +Beta_value(Low-high)

=3% +2*4% + 0.2*(14%-10%) + 0.5*(13%-9.5%) = 3% +8% +0.8% + 2.25% = 14.05%

Cost of equity = R_f + Beta_regular*Market risk Premium + Beta_size*(Small-Big) +Beta_value(Low-high) + Beta_liq*(illiquid - liquid)

=3% +2*4% + 0.2*(14%-10%) + 0.5*(13%-9.5%) +0.15*(13.5%-9%)

= 3% +8% +0.8% + 2.25% 0.675% = 14.725%

d) First of all we need to find the growth rate:

growth rate = ROE*(1-Payout ratio) = 10%* (1-2.45/4) = 3.875%

Cost of equity by gordon growth model = (DPS*(1+growth rate)/market price) + growth rate

= (2.45*(1+3.875%)/60)+ 3.875% = 8.12%

jeff jeffy answered 1 year ago

Next > < Previous

Related Solutions

USE THE FOLLOWING INFORMATION FOR THE NEXT 2 QUESTIONS Cornell Products has the following information available...

USE THE FOLLOWING INFORMATION FOR THE NEXT 2 QUESTIONS Cornell Products has the following information available for 2020: UNITS BEGINNING INVENTORY-----0 UNITS ENDING INVENTORY----5,400 UNITS COSTS Direct materials $1.00 per unit Direct labor $2.00 per unit Variable manufacturing overhead $1.50 per unit Variable selling and administrative costs $ .50 per unit Fixed manufacturing overhead $30,000/6,000 = $5.00 per unit Fixed selling and administrative costs $25,000 During 2020, Cornell produced 6,000 units out of which 5,400 units...

.Use This information for the next 3 questions: You buy a 2 million dollar building for...

.Use This information for the next 3 questions: You buy a 2 million dollar building for an 8 year project. You can depreciate it over 20 years. In 8 years, you sell the building for 1.6 million dollars. Over the 8 year project, you project needing net working capital as follows Years 0, 1, 2, you need 100,000 of capital Years 3, 4, 5 you need 140,000 of capital Years 6, 7, 8 you need 175,000 of capital Because you...

Use the following information to answer the next 10 questions: A company with 100,000 authorized shares...

Use the following information to answer the next 10 questions: A company with 100,000 authorized shares of $4 par common stock issued 50,000 shares at $9 per share. Subsequently, the company declared and issued a 10% stock dividend. The market price of the shares is $20 per share. What is the effect of the dividend on Retained Earnings? Retained earnings decreased Retained earnings increased Retained earnings remained the same None of the above Refer to the previous question. By what...

Use the following information to answer the next 10 questions: A company with 50,000 authorized shares...

Use the following information to answer the next 10 questions: A company with 50,000 authorized shares of $1 par common stock issued 10,000 shares at $10 per share. Subsequently, the company declared and paid a $3 cash dividend per share. On the date the company declared the dividend, the market price of the shares was $30 per share. What is the effect of the dividend on Retained Earnings? Retained earnings decreased Retained earnings increased Retained earnings remained the same None...

Use the following information to answer the next six questions: All balances are as of 12/31/2017...

Use the following information to answer the next six questions: All balances are as of 12/31/2017 unless specified otherwise. Loss on the Sale of Equipment 62,250 Income Tax Expense 48,750 Short Term Investments 1,500 Inventory 97,500 Retained Earnings, 1/1/17 281,000 Gain on Sale of Equipment 27,500 Goodwill 50,000 Cost of Goods Sold 204,000 Common Stock ??? Notes Payable 5/1/18 12,500 Cash 70,000 Sales Revenue 447,500 Accumulated Depreciation 50,000 Dividends 10,000 Notes Payable, due 12/31/19 104,500 Prepaid Expenses 2,500 Furniture 83,000...

i dont know questions 9 and 10 Use the following information to answer the next six...

i dont know questions 9 and 10 Use the following information to answer the next six questions: All balances are as of 12/31/2017 unless specified otherwise. Loss on the Sale of Equipment 62,250 Income Tax Expense 48,750 Short Term Investments 1,500 Inventory 97,500 Retained Earnings, 1/1/17 281,000 Gain on Sale of Equipment 27,500 Goodwill 50,000 Cost of Goods Sold 204,000 Common Stock ??? Notes Payable 5/1/18 12,500 Cash 70,000 Sales Revenue 447,500 Accumulated Depreciation 50,000 Dividends 10,000 Notes Payable, due...

Use the following information to answer the next six questions: Regency Rug Repair Company is trying...

Use the following information to answer the next six questions: Regency Rug Repair Company is trying to decide whether it should relax its credit standards. The firm repairs 72,000 rugs per year at an average price of $132 each. Bad-debt expenses are 1% of sales, the average collection period is 40 days, and the variable cost per unit is $28. Regency expects that if it does relax its credit standards, the average collection period will increase to 48 days and...

USE THE FOLLOWING INFORMATION FOR THE NEXT 2 INDEPENDENT QUESTIONS: Tremaine Inc. has three product...

USE THE FOLLOWING INFORMATION FOR THE NEXT 2 INDEPENDENT QUESTIONS: Tremaine Inc. has three product lines: A, B, and C. A B C Total Sales $50,000 $85,000 $90,000 $225,000 Variable costs 30,000 30,000 44,000 104,000 Contribution margin 20,000 55,000 46,000 121,000 Fixed costs 23,000 25,000 18,000 66,000 Net income $ (3,000) $30,000 $28,000 $ 55,000 28. Management is considering dropping product line A. If it is discontinued, $18,000 of its fixed costs are DTFC & can be avoided....

Use the following information to answer the next two questions: On January 2, 2004, Shady Corp....

Use the following information to answer the next two questions: On January 2, 2004, Shady Corp. acquired equipment for $110,000. The estimated life of the equipment is 5 years, the estimated residual value is $10,000 and Shady Corp. uses the straight-line method for computing depreciation expense. On June 30th of 2006 (2 and ½ years after acquiring the asset), Shady Corp sold the equipment for $50,000. What two journals entries were made on June 30th, 2006, on the date the...

Use the following information for the next 2 questions: Grasshopper Inc. is considering a 5-year project...

Use the following information for the next 2 questions: Grasshopper Inc. is considering a 5-year project amid the pandemic shutdown. They need to buy a new IT system for $32,000. The new system also requires an increase in net working capital of $4,000. Grasshopper expects $16,000 in sales and $7,400 annual operating expenses. Annual depreciation is $8,000. If the firm's tax rate is 21% and its cost of capital is 12%, 59) How much is their annual OCF? Question 59...

Subjects