Question

Growth​ Company's current share price is $ 20.25 and it is expected to pay a $ 1.00 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 $ 2.25 per share fixed dividend. If this stock is currently priced at $ 28.15​, what is Growth​ Company's cost of preferred​ stock? c. Growth Company has existing debt issued three years ago with a coupon rate of 5.8 %. The firm just issued new debt at par with a coupon rate of 6.5 %. What is Growth​ Company's cost of​ debt? d. Growth Company has 4.9 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 $ 20.1 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.

Answer 1

(a) Current Price = $ 20.25 = P0, Expected Dividend = D1 = $ 1 and Dividend Growth Rate = 39 % = g

Cost of Equity = Ke = (D1/P0) + g = (1/20.25) + 0.039 = 0.08838 or 8.838% ~ 8.84 %

(b) Preferred Stock Dividend = $ 2.25 and Preferred Stock Price = $ 28.15

Therefore, Cost of Preferred Stock = Kp = Dividend / Stock Price = 2.25 / 28.15 = 0.07993 or 7.993 % ~ 7.99%

(c) As the new debt is issued at par, the new debt's cost should equal its coupon rate. Coupon Rate = 6.5 %

Therefore, Cost of Debt = Kd = 6.5 %

(d) Number of Common Shares = 4.9 million and price per common share = $ 20.25

Market Value of Common Shares = C = 4.9 x 20.25 = $ 99.225 million

Number of Preferred Shares = 1.4 million and Price per Preferred Share = $ 28.15

Market Value of Preferred Shares = P = 1.4 x 28.15 = $ 39.41 millionn

Market Value of Liabilities = D = $ 20.1 million

Growth Company's Asset Value = A = C +P + D = 99.225 + 39.41 + 20.1 = $ 158.735 million

(e) Tax Rate = 38 %

Therefore, WACC = Kd x (1-Tax Rate) x (D/A) + Ke x (E/A) + Kp x (P/A) = 6.5 x (1-0.38) x (20.1/158.375) + 8.84 x (99.225/158.375) + 7.99 x (39.41/158.375) = 803812 % ~ 8.04 %