Question

Growth​ Company's current share price is $ 20.20 and it is expected to pay a $ 1.20 dividend per share next year. After​ that, the​ firm's dividends are expected to grow at a rate of 3.9 % per year. a. What is an estimate of Growth​ Company's cost of​ equity? b. Growth Company also has preferred stock outstanding that pays a $ 2.20 per share fixed dividend. If this stock is currently priced at $ 28.00​, what is Growth​ Company's cost of preferred​ stock? c. Growth Company has existing debt issued three years ago with a coupon rate of 6.4 %. The firm just issued new debt at par with a coupon rate of 6.7 %. What is Growth​ Company's cost of​ debt? d. Growth Company has 4.8 million common shares outstanding and 1.4 million preferred shares​ outstanding, and its equity has a total book value of $ 50.0 million. Its liabilities have a market value of $ 19.7 million. If Growth​ Company's common and preferred shares are priced as in parts ​(a​) and ​(b​), what is the market value of Growth​ Company's assets? e. Growth Company faces a 38 % tax rate. Given the information in parts ​(a​) through ​(d​), and your answers to those​ problems, what is Growth​ Company's WACC? ​Note: Assume that the firm will always be able to utilize its full interest tax shield. a. What is an estimate of Growth​ Company's cost of​ equity? The required return​ (cost of​ capital) of levered equity is 9.84​%. ​(Round to two decimal​ places.) b. Growth Company also has preferred stock outstanding that pays a $ 2.20 per share fixed dividend. If this stock is currently priced at $ 28.00​, what is Growth​ Company's cost of preferred​ stock? The cost of capital for preferred stock is 7.86​%. ​(Round to two decimal​ places.) c. Growth Company has existing debt issued three years ago with a coupon rate of 6.4 %. The firm just issued new debt at par with a coupon rate of 6.7 %. What is Growth​ Company's cost of​ debt? ​ (Select from the​ drop-down menus.) The​ pre-tax cost of debt is the​ firm's YTM on current debt. Since the firm recently issued debt at​ par, then the coupon rate of that debt must be equal to the YTM of the debt.​ Thus, the​ pre-tax cost of debt is 6.7% . d. Growth Company has 4.8 million common shares outstanding and 1.4 million preferred shares​ outstanding, and its equity has a total book value of $ 50.0 million. Its liabilities have a market value of $ 19.7 million. If Growth​ Company's common and preferred shares are priced as in parts ​(a​) and ​(b​), what is the market value of Growth​ Company's assets? The market value of assets is ​$ nothing million.  ​(Round to two decimal​ places.)

Answer 1

a)	Cost of Company
	= (D1 / P0) + g
	Where,
	D1 = Dividend of Next Year = $1.20
	P0 = Current Share Price = $20.20
	g = Expected Growth Rate = 3.9% = 0.039
	So,
	Cost of Company
	= (D1 / P0) + g
	= ($1.20 / $20.20) + 0.039
	= 0.0594 + 0.039
	= 0.0984
	i.e. 9.84%
b)	Cost of Preferred Stock
	= Fixed Dividend / Current Price
	= $2.20 / $28
	= 0.0786
	i.e. 7.86%
c)	The Pre Tax Cost of Debt is the YTM of the Company on Current Debt.
	Growth Company just issued new debt at par with Coupon Rate of 6.7%.
	So Coupon Rate will be the pre Tax Cost of Debt i.e. 6.7%
	Pre Tax Cost of Debt = 6.70%
	After Tax Cost of Debt
	= Pre Tax Cost of Debt*(1-Tax Rate)
	= 6.70%*(1-38%)
	= 6.70%*0.62
	= 4.154%
d)	Market Value of Company's Assets
	= Marekt Value Debt + Market Value of Preferred Stock + Market Value of Common Shares
	= Marekt Value Liabilities + (No. of Shares*Current Stock Price) + (No. of Shares*Current Stock Price of Common Shares)
	= $19,700,000 + (1400000*$28) + (4800000*$20.20)
	= $19,700,000 + $39,200,000 + $96,960,000
	= $155,860,000
e)	Market Weight Formula = Market Value of respective Source / Total Market Value
	Source	Market Value	Market Weight Formula	Market Weight	Cost	Cost*Weight
	Equity	$96,960,000	= 96960000 / 155860000	0.6221	9.840%	6.12%
	Preferred Stock	$39,200,000	= 39200000 / 155860000	0.2515	7.860%	1.98%
	Debt	$19,700,000	= 19700000 / 155860000	0.1264	4.154%	0.53%
		$155,860,000				8.62%
	WACC = 8.62%