Question

Growth​ Company's current share price is

$19.85

and it is expected to pay a

$1.30

dividend per share next year. After​ that, the​ firm's dividends are expected to grow at a rate of

3.5%

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

$1.85

per share fixed dividend. If this stock is currently priced at

$28.20​,

what is Growth​ Company's cost of preferred​ stock?

c. Growth Company has existing debt issued three years ago with a coupon rate of

5.7%.

The firm just issued new debt at par with a coupon rate of

6.1%.

What is Growth​ Company's cost of​ debt?

d. Growth Company has

4.6

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

$20.2

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

Answer a)

Value of Stock =

19.85 =

19.85 * Rate of Return - 19.85 * 0.035 = 1.3455

Rate of Return = 1.3455 + 0.69475 / 19.85

Rate of Return = 10.28%

Cost of Equity = 10.28%

Answer b)

Cost of Preferred Shares = Dividend / Share Price

= 1.85 / 28.2

= 6.56%

Answer c)

Cost of Debt = 6.1%

Answer d)

Value of Company = Value of Equity Shares + Value of Preferred Shares + Value of Debt

= 4.6 mn * 19.85 + 1.4 * 28.2 + 20.2

= 150.99

Answer e)

WACC =  (Cost of Equity * Weight of Equity) + (Cost of Debt after tax * Weight of Debt) + (Cost of Preferred Stock * Cost of Preferred Stock)

= 10.28% * 4.6*19.85 / 150.99 + 6.1% * (1-0.38) * 1.4 * 28.2 / 150.99 + 6.56% * 20.2 / 150.99

= 6.22% + 0.99 + 0.88

= 8.09%

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