Common stock: Price=$48, div(t=0)=$2.25, g=3%. 100m shares outstanding Preferred stock: Price=$80, perpetual annual dividend=$6.50. 2.5m shares...

Common stock: Price=$48, div(t=0)=$2.25, g=3%.

100m shares outstanding

Preferred stock: Price=$80, perpetual annual dividend=$6.50.

2.5m shares outstanding

Bonds: Price=$1000, YTM=7% (semiannual coupons), Par=$1000, 13 years until maturity.

5m bonds outstanding

Use the DCF approach to calculate the cost of common equity. Ignore flotation costs.

Calculate the component cost of preferred stock. Ignore flotation costs.

Assuming a tax rate of 40%, calculate the after-tax component cost of debt.

Calculate Firm A’s WACC. Assume the firm is currently operating at its target capital structure (in this case, market weights = target weights).

Assume Firm B’s FCFs are as follows: Year 1: $120m, Year 2: $200m, and g=4% after Year 2. WACC=7%. Use the Corporate Valuation Model to calculate Firm B’s total market value. Ignore flotation costs.

Expert Solution

PART A

Price of Equity based on Dividend Discount Model = D1/(Ke-g)

48 = (2.25*1.03)/ (Ke-3%) :: Ke = 7.83% (A)

Cost of preferred stock = 6.50/80 = 8.125% (B), using the formula : Dividend / price

Cost of bond = 7%*(1-Taxrate 40%) = 4.2% (C), using the formula : Pretax*(1-tax rate)

WACC = 6.02% (Multiplication of individual capital structure weight with return)

PART B

Perpepetual cash flow calculated by Dividend Discount Model = D1/(Ke-g) = (200*1.04)/(7%-4%) = $6,933 Million

Discount factor = 1/(1+rate)^no. of years

Market Value of $6,343 Million.

|Type Equity Preferred Stock Debt No. In million Price Value Weight Cost 4800 0.48 7.83% 2.5 2001 0.02 8.13% 5 1000| 5000| 0.5 4.20% Product (Weight"Cost) | 3.76% 0.16% 2.10% 80 C WACC 6.02%

Year 2 Year 1 120 200 Cash Flow Perpetual cash flow 6,933 Total 1201 7,133 Discount Factor@7% 0.93 0.87 Amount 112 6,231 Total 6,343

jeff jeffy answered 1 year ago

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