7211TutAnswersWk11_109

7211TutAnswersWk11_109 - 7211afe Tutorial Suggested Answers...

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7211afe Tutorial Suggested Answers for Week 11 Question 1 Parrot Industries’ most recent dividend was $1.80 per share, and dividends are expected to grow at a 5% annual rate indefinitely. If the stock sells for $34 per share, what is your best estimate of Parrot’s cost of equity? Solution: Using the dividend growth model: ( 29 g k g D g k D P s s - + = - = 1 0 1 0 , so ( 29 g P g D g P D k s + + = + = 0 0 0 1 1 . ( 29 05 . 0 34 05 . 0 1 80 . 1 + + = s k = .1056 or 10.56% Parrot’s cost of equity estimated at 10.56%.
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Question 2 ABC Corporation has a target capital structure of 50% common stock, 5% preferred stock, and 45% debt. Its cost of equity is 16%, cost of preferred is 7.5% and the YTM of its bonds is 9%. The relevant tax rate is 35%. a) What is WACC? b) The company president approaches you about the capital structure. He wants to know why the company doesn’t use more preferred stock financing, since it costs less than the YTM. What would you tell the president? Solution:
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7211TutAnswersWk11_109 - 7211afe Tutorial Suggested Answers...

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