Multiple
part:
(The
following information applies to the next six problems.)
Rollins Corporation is estimating its
WACC. Its target capital structure is 20
percent debt, 20 percent preferred stock, and 60 percent common equity. Its
bonds have a 12 percent coupon, paid semiannually, a current maturity of 20
years, and sell for $1,000. 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 policy is to use a risk premium of 4 percentage points when
using the bond-yield-plus-risk-premium method to find rs. The firm’s marginal tax rate is 40 percent.
[i]. What
is Rollins’ component cost of debt?
a. 10.0%
b.
9.1%
c.
8.6%
d.
8.0%
e.
7.2%
[ii]. What
is Rollins’ cost of preferred stock?
a. 10.0%
b. 11.0%
c. 12.0%
d. 12.6%
e. 13.2%
[iii]. What
is Rollins’ cost of common stock (rs) using the CAPM approach?
a. 13.6%
b. 14.1%
c. 16.0%
d. 16.6%
e. 16.9%
[iv]. What
is the firm’s cost of common stock (rs) using the DCF approach?
a. 13.6%
b. 14.1%
c. 16.0%
d. 16.6%
e. 16.9%
[v]. What
is Rollins’ cost of common stock using the bond-yield-plus-risk-premium
approach?
a. 13.6%
b. 14.1%
c. 16.0%
d. 16.6%
e. 16.9%
[vi]. What
is Rollins’ WACC?
a. 13.6%
b. 14.1%
c. 16.0%
d. 16.6%
e. 16.9%
(The
following information applies to the next three problems.)
J. Ross and Sons Inc. has a target capital
structure that calls for 40 percent debt, 10 percent preferred stock, and 50
percent common equity. The firm’s
current after?tax cost of debt is 6 percent, and it can sell as much debt as it
wishes at this rate. The firm’s
preferred stock currently sells for $90 per share and pays a dividend of $10
per share; however, the firm will net only $80 per share from the sale of new
preferred stock. Ross’s common stock
currently sells for $40 per share. The
firm recently paid a dividend of $2 per share on its common stock, and
investors expect the dividend to grow indefinitely at a constant rate of 10
percent per year.
[vii]. What
is the firm’s cost of common stock, rs?
a. 10.0%
b. 12.5%
c. 15.5%
d. 16.5%
e. 18.0%
[viii]. What
is the firm’s cost of newly issued preferred stock, rps?
a. 10.0%
b. 12.5%
c. 15.5%
d. 16.5%
e. 18.0%
[ix]. What
is the firm’s weighted average cost of capital (WACC)?
a.
9.5%
b. 10.3%
c. 10.8%
d. 11.4%
e. 11.9%
Answer: a
[x]. Allison
Engines Corporation has established a target capital structure of 40 percent
debt and 60 percent common equity. The
firm expects to earn $600 in after-tax income during the coming year, and it
will retain 40 percent of those earnings.
The current market price of the firm’s stock is P0 = $28; its
last dividend was D0 = $2.20, and its expected growth rate is 6
percent. Allison can issue new common
stock at a 15 percent flotation cost.
What will Allison’s marginal cost of equity
capital (not the WACC) be if it must fund a capital budget requiring
$600 in total new capital?
a. 15.8%
b. 13.9%
c. 7.9%
d. 14.3%
e. 9.7%
[xi]. Hilliard
Corp. wants to calculate its weighted average cost of capital (WACC). The company’s CFO has collected the following
information:
·
The
company’s long-term bonds currently offer a yield to maturity of 8 percent.
·
The
company’s stock price is $32 per share (P0 = $32).
·
The
company recently paid a dividend of $2 per share (D0 = $2.00).
·
The
dividend is expected to grow at a constant rate of 6 percent a year (g = 6%).
·
The
company pays a 10 percent flotation cost whenever it issues new common stock (F
= 10%).
·
The
company’s target capital structure is 75 percent equity and 25 percent debt.
·
The
company’s tax rate is 40 percent.
·
The
company anticipates issuing new common stock during the upcoming year.
What
is the company’s WACC?
a. 10.67%
b. 11.22%
c. 11.47%
d. 12.02%
e. 12.56%
%.
