FIN3300 Solution Ch14 (W 0811)

# FIN3300 Solution Ch14 (W 0811) - 5 The cost of preferred...

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Solution Chapter 14: Cost of Capital Page 465 Questions: 1, 4, 5, 7, 9, 10 1. With the information given, we can find the cost of equity using the dividend growth model. Using this model, the cost of equity is: R E = [\$2.40(1.055)/\$52] + .055 = .1037 or 10.37% 4. To use the dividend growth model, we first need to find the growth rate in dividends. So, the increase in dividends each year was: g 1 = (\$1.12 – 1.05)/\$1.05 = .0667 or 6.67% g 2 = (\$1.19 – 1.12)/\$1.12 = .0625 or 6.25% g 3 = (\$1.30 – 1.19)/\$1.19 = .0924 or 9.24% g 4 = (\$1.43 – 1.30)/\$1.30 = .1000 or 10.00% So, the average arithmetic growth rate in dividends was: g = (.0667 + .0625 + .0924 + .1000)/4 = .0804 or 8.04% Using this growth rate in the dividend growth model, we find the cost of equity is: R E = [\$1.43(1.0804)/\$45.00] + .0804 = .1147 or 11.47% Calculating the geometric growth rate in dividends, we find: \$1.43 = \$1.05(1 + g) 4 g = .0803 or 8.03% The cost of equity using the geometric dividend growth rate is: R E = [\$1.43(1.0803)/\$45.00] + .0803 = .1146 or 11.46%

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Unformatted text preview: 5. The cost of preferred stock is the dividend payment divided by the price, so: R P = \$6/\$96 = .0625 or 6.25% 7. a. The pretax cost of debt is the YTM of the company’s bonds, so: P = \$950 = \$40(PVIFA R%,46 ) + \$1,000(PVIF R%,46 ) R = 4.249% YTM = 2 × 4.249% = 8.50% 1 b. The aftertax cost of debt is: R D = .0850(1 – .35) = .0552 or 5.52% c. The after-tax rate is more relevant because that is the actual cost to the company. 9. a. Using the equation to calculate the WACC, we find: WACC = .60(.14) + .05(.06) + .35(.08)(1 – .35) = .1052 or 10.52% b. Since interest is tax deductible and dividends are not, we must look at the after-tax cost of debt, which is: .08(1 – .35) = .0520 or 5.20% Hence, on an after-tax basis, debt is cheaper than the preferred stock. 10. Here we need to use the debt-equity ratio to calculate the WACC. Doing so, we find: WACC = .15(1/1.65) + .09(.65/1.65)(1 – .35) = .1140 or 11.40% 2...
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## This note was uploaded on 05/18/2011 for the course FINANCE Fin3300 taught by Professor Mosley during the Summer '10 term at CSU East Bay.

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FIN3300 Solution Ch14 (W 0811) - 5 The cost of preferred...

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