case study:
1. A company’s perpetual preferred stock sells for $102.50 per share, and it pays a $9.50 annual dividend. What is the company’s cost of preferred stock for use in calculating the WACC?
2. Assume that you are a financial analyst and you have been provided with the following data: rrf = 4.00%; rmkt = 14.00%; and β = 1.15. What is the cost of equity from retained earnings based on the CAPM approach?
3. A company is estimating its cost of common equity capital and it has the following relevant information: D1 = $1.30; P0 = $42.50; and g = 7.00% (constant). What is the cost of equity from retained earnings based on the dividend discount (constant) model approach?
4. Assume a company issued 20-year debt oneyearago at par value carrying a coupon
rate of 8 percent (payable annually). Today, the debt is selling at $1,050 (PV = $1,050).
If the firm’s tax bracket is 35 percent, what is the after-tax cost of debt for this firm?
5. Suppose a regulated public utility is expected to provide steady (constant) growth of
dividends of 5 percent per year for the indefinite future. Its last dividend was $5 per
share (DIVo = $5.00); the stock sold for $60 in the secondary market just after the $5
dividend was paid. What is the company’s cost of equity capital (rs)?
6. The common stock of a company has a beta of 0.90. The Treasury bill rate (rrf) is 4
percent, and the return on the market is 12 percent (rmkt = 12%). This company has a
capital structure is 30 percent debt, paying a 5 percent interest rate (rd = 5%), and 70
percent equity.
a. What is cost of equity capital(rs)?
b. What is the weighted average cost of capital (WACC)? Assume a 40 percent marginal
tax rate.
7. Company X has 2 million shares of common stock outstanding at a book value of $2.00 per share. The stock trades for $3.00 per share. It also has $2 million in face value of debt that trades at 90% of par. What is its ratio of debt (wd) for WACC purposes?
8. What would you estimate to be the required rate of return for equity investors (rs) if a stock sells for $40.00 and will pay a $4.40 dividend that is expected to grow at a constant rate of 5%?
9. A company’s CFO wants to maintain a target debt-to-equity ratio of ¼ (this implies
that D/E = 0.25%). If the WACC is 18.6%, and the pre-tax cost of debt is 9.4%, what is
the cost of common equity (rs) assuming a tax rate of 34%?
10. What is the WACC for a firm with 40% debt, 20% preferred stock, and 40% equity if the respective costs for these components are 6% before tax, 12% after tax, and 18% before tax? The firm’s tax rate is 35%. Note: Be sure to consider how taxes apply to the different components of the WACC.
11. Suppose a company has 30,000 shares of common stock outstanding at a market price of $15.00 a share. This stock was originally issued at $31 per share. The firm also has a bond issue outstanding with a total face value of $280,000 which is selling for 86 percent of par. The cost of equity is 13 percent while the aftertax cost of debt is 6.9 percent. The firm has a beta of 1.48 and a tax rate of 30 percent. What is the weighted average cost of capital?
12. Coldwell & Sons has a capital structure which is based on 40 percent debt, 5 percent preferred stock, and 55 percent common stock. The pre-tax cost of debt is 7.5 percent, the cost of preferred is 9 percent, and the cost of common stock is 13 percent. The company’s tax rate is 39 percent. The company is considering a project that is equally as risky as the overall firm. This project has initial costs of $325,000 and annual cash inflows of $87,000, $279,000, and $116,000 over the next three years, respectively. What is the projected net present value of this project?
13. Best Mattress has an overall beta of 0.79 and a cost of equity of 11.2 percent for the firm overall. The firm is 100 percent financed with common stock. Division X within the firm has an estimated beta of 1.08 and is the riskiest of all of the firm’s operations. What is an appropriate cost of capital for Division X if the market risk premium is 9.5 percent?
homework:
Please be sure to round your answers to two (2) decimal places; also, please note that for problems dealing with a percentage answer such as rates of return on stocks, your calculator should be set to four (4) decimal places so that after converting your answer to percentage terms your final solution will be rounded to two places.
1. A company is expected to pay an annual dividend of $0.80 a share next year. The market price of the stock is $19.60 and the growth rate is 5 percent. What is the firm’s cost of equity?
2. Suppose the common stock of a company has a negative growth rate of 1.5 percent and a required return of 18 percent. The current stock price is $11.40. What was the amount of the last dividend paid?
3. Phillips Lighting, Inc. has a current beta of 1.21. The market risk premium is 8.9 percent and the risk-free rate of return is 3.2 percent. By how much will the cost of equity increase if the company expands its operations such that the company beta rises to 1.50?
4. Suppose a company has 20-year, semi-annual bonds outstanding with a 5 percent coupon. The face amount of each bond is $1,000. These bonds are currently selling for 114 percent of face value (that is, the bonds are selling at a premium over par). What is the company’s pre-tax cost of debt? If the firm pays an average tax rate of 40%, what is the after-tax cost of debt?
5. Christensen Cabinet Works maintains a debt-equity ratio of 0.65 and has a tax rate of 32 percent. The firm does not issue preferred stock. The pre-tax cost of debt is 9.8 percent. There are 25,000 shares of stock outstanding with a beta of 1.2 and a market price of $19 a share. The current market risk premium is 8.5 percent and the current risk-free rate is 3.6 percent. This year, the firm paid an annual dividend of $1.10 a share and expects to increase that amount by 2 percent each year. Using an average expected cost of equity, what is the weighted average cost of capital?
6. A local company has 1,200 bonds outstanding that are selling for $990 each. The company also has 2,500 shares of preferred stock at a market price of $28 a share. The common stock is priced at $37 a share and there are 28,000 shares outstanding. What is the weight of the common stock as it relates to the firm’s weighted average cost of capital?
7. A multi-bank holding company has 80,000 bonds outstanding that are selling at par. Bonds with similar characteristics are yielding 7.5 percent. The company also has 750,000 shares of 7 percent preferred stock and 2.5 million shares of common stock outstanding. The preferred stock sells for $65 a share. The common stock has a beta of 1.34 and sells for $42 a share. The U.S. Treasury bill is yielding 2.8 percent and the return on the market is 11.2 percent. The corporate tax rate is 38 percent. What is the firm’s weighted average cost of capital?
