Question

Problem

The Smith Company has 10,000 bonds outstanding. The bonds are selling at 102% of face value, have a 8% coupon rate, pay interest annually, mature in 10 years, and have a face value of $1,000. There are 500,000 shares of 9% preferred stock outstanding with a current market price of $91 a share and a par value of $100. In addition, there are 1.25 million shares of common stock outstanding with a market price of $64 a share and a beta of .95. The most recent dividend paid by the company on the common stock was of $1.10 and it expects to increase those dividends by 3% annually forever. The firm's marginal tax rate is 35%. The overall stock market is yielding 12% and the Treasury bill rate is 3.5%.

1. What is the cost of equity based on the dividend growth model?
2. What is the cost of equity based on the security market line?
3. What market weights should be given to the various capital components in the weighted average cost of capital computation?

4. What is the weighted average cost of capital using the cost equity calculated based on CAPM?

(Please provide all the equation and step by step or Excel.xml in google drive )

(Please don't copy from another places, the answer will upload to Turnitin)

Answer 1

cost of equity based on the dividend growth model = D*(1+g)/P + g

cost of equity based on the security market line is based on the CAPM

The required rate of return R(e) is calculated by CAPM model

R(e) = r(f) + Beta*(R(m) - r(f))

R(m) is the market return

r(f) is the risk-free rate

Stock price	64
Dividends	1.1
Growth rate	0.03
Riskfree rate	0.035
Market return	0.12
Beta	0.95
Cost of equity (Dividend growth)	=((B2*(1+B3))/B1)+B3
Cost of equity (CAPM)	=B4+B6*(B5-B4)
	Bond/shares	Price	Market value	Weights	Return	Weighted return
Debt	10000	=1000*102%	=B11*C11	=D11/$E$14	=RATE(10,1000*8%,-C11,1000)	=E11*F11*(1-35%)
Preferred stock	500000	91	=B12*C12	=D12/$E$14	=100*9%/C12	=E12*F12
Common stock	1250000	64	=B13*C13	=D13/$E$14	=B8	=E13*F13
Total market value	=D11+D12+D13
WACC	=G11+G12+G13

Stock price	64
Dividends	1.1
Growth rate	3%
Riskfree rate	3.50%
Market return	12%
Beta	0.95
Cost of equity (Dividend growth)	4.77%
Cost of equity (CAPM)	11.58%
	Bond/shares	Price	Market value	Weights	Return	Weighted return
Debt	10000	1020	10200000	7.52%	7.71%	0.38%
Preferred stock	500000	91	45500000	33.53%	9.89%	3.32%
Common stock	1250000	64	80000000	58.95%	11.58%	6.82%
Total market value	135700000
WACC	0.10516507