Question

1. The following data are required in this question and the next three. Rollins Corporation is constructing its MCC schedule. Its target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 10 percent coupon, paid semiannually, a current maturity of 20 years, and sell for $849.54. The firm could sell, at par, $100 preferred stock which pays a 12 percent annual dividend, but flotation costs of 5 percent would be incurred. Rollins' beta is 1.2, the risk-free rate is 10 percent, and the market risk premium is 5 percent. Rollins is a constant growth firm which just paid a dividend of $2.00, sells for $27.00 per share, and has a growth rate of 8 percent. The firm's net income is expected to be $1 million, and its dividend payout ratio is 40 percent. Flotation costs on new common stock total 10 percent, and the firm's marginal tax rate is 40 percent. What is Rollins' component cost of debt?

   		9.1%
   		8.6%
   		8.0%
   		7.2%

1. What is the firm's cost of preferred stock?

   		10.53%
   		12.00%
   		12.63%
   		13.17%

1. What is the firm's cost of retained earnings using the discounted cash flow approach?

   		14.1%
   		16.0%
   		16.6%
   		16.9%

1. What is the cost of new common stock?

   		16%
   		16.6%
   		16.9%
   		17.4%

Answer 1

Therefore, cost of debt component =7.20%

Cost of preferred stock is calculated using the following equation

Cost of preferred stock = D/(P*(1-f))

Where, D is annual dividend

P is price of preferre stock

f is floatation cost

Preferred dividend = 12*100 =$12

Cost of preferred stock = 12/(100*(1-0.05))

= 12.63%

Cost of retained earnings using discounted cash flow approach is calculated below

Cost of retained earnings = (D0*(1+g)/P0)+g

Where, D0 is the recently paid dividend

g is the growth rate

P0 is the current stock price

Cost of retained earnings = (2*(1+0.08)/27)+0.08

= 16%

Cost of new common stock is calculated using the following equation

Cost of new equity = [D0*(1+g)/(P0(1-f))]+g

Where, f is the flotation cost as a percentage

Cost of new equity = [2*(1+0.08)/(27*(1-0.10))]+0.08

= 16.9%