Question

Sales $1,000
Net Income $50
Total Assets $2,000
Shareholder equity $750
Tax rate 40.0%

Bond Issue: 1.5 million bonds that are $1,000 par value 20-year 5.0% coupon bonds with semiannual
payments with a yield to maturity of 7.0%.

100.0 million shares of stock outstanding
Market price per share $20.00
2.0 million shares of $8.00 per share dividend preferred stock
Market price per share of preferred stock $225.00
Percentage flotation costs per share for preferred stock 8.0%
Company's stock beta 1.25
Risk free rate 3.0%
Expected return on the market 9.5%
Market risk premium 6.5%
Expected dividend next year on common stock $2.00 per share
Expected growth rate in common stock dividends 6.0%

1. Calculate the percentage of common stock in the company's market value capital structure                                         

a.         44.08%                                                            

b.         45.73%                                                            

c.         49.59%                                                            

d.         55.10%                                                            

e.         62.26%                                                            

                                                                        

2. Calculate the CAPM required return on the company's common stock                                                                   

a.         9.68%                                                  

b.         10.01%                                                            

c.         11.13%                                                            

d.         12.24%                                                            

e.         13.35%                                                            

                                                                        

3. Calculate the DCF (dividend growth model) required return on the company's common stock                                         

a.         6.67%                                                  

b.         10.60%                                                            

c.         14.40%                                                            

d.         16.00%                                                            

e.         16.16%                                                            

                                                                        

4. Calculate the required return on the company's preferred stock.                                                               

a.         3.86%                                                  

b.         4.06%                                                  

c.         4.25%                                                  

d.         4.44%                                                  

e.         4.64%                                                  

Answer 1

1. Price of the bond has to be found using PV function in EXCEL

=PV(rate,nper,pmt,fv,type)

Please remeber that the payments are semi-annual

rate=7%/2=3.5%

nper=20 years*2=40

pmt=semi-annual coupon=(coupon rate*face value)/2=(5%*1000)/2=50/2=25

fv=1000

=PV(3.5%,40,25,1000,0)=$786.45

Market value of debt=nummber of bonds*price of bond=1.5*786.45=1179.67 million

Market value of common stock=number of shares*price per share=100*20=2000 million

Market value of preferred stock=number of preferred stock*share price=2*225=450 million

Total value=1179.67+2000+450=3629.67

Common stock share=2000/3629.67=55.10%

Option d is correct

2. required return on common stock using CAPM=risk free rate+(beta*market risk premium)=3%+(1.25*6.5%)=11.13%

option c is correct

3. required rate of return on DCF=(D1/Sahre price)+growth rate=(2/20)+6%=10%+6%=16%

Option d is correct

4. required return on preferred stock=annual dividend/(Preferred stock price-flotation cost)=8/(225-(8%*225))=8/207=3.86%

Option a is correct