fm10 8 - Therefore, r ps = $11/$100(1 - 0.05) = $11/$95 =...

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Answers and Solutions: 10 - 8 Common Stock : The market value of the common stock is 4,000,000($20) = $80,000,000. Therefore, here is the firm's market value capital structure, which we assume to be optimal: Long-term debt $ 20,970,000 20.05% Preferred stock 3,636,500 3.48 Common equity 80,000,000 76.47 $104,606,500 100.00 % We would round these weights to 20 percent debt, 4 percent preferred, and 76 percent common equity. Step 2 . Establish cost rates for the various capital structure components. Debt cost : r d (1 - T) = 12%(0.6) = 7.2%. Preferred cost : Annual dividend on new preferred = 11%($100) = $11.
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Unformatted text preview: Therefore, r ps = $11/$100(1 - 0.05) = $11/$95 = 11.6%. Common equity cost : There are three basic ways of estimating r s : CAPM, DCF, and risk premium over own bonds. None of the methods is very exact. CAPM : We would use r RF = T-bond rate = 10%. For RP M , we would use 4.5% to 5.5%. For beta, we would use a beta in the 1.3 to 1.7 range. Combining these values, we obtain this range of values for r s : Highest: r s = 10% + (5.5)(1.7) = 19.35%. Lowest: r s = 10% + (4.5)(1.3) = 15.85%. Midpoint: r s = 10% + (5.0)(1.5) = 17.50%....
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