The market risk premium is 5 percent The stocks beta is 14 The company expects

# The market risk premium is 5 percent the stocks beta

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The risk-free rate is 3 percent.The market risk premium is 5 percent.The stock’s beta is 1.4.The company expects to pay a dividend on its common stock of \$1.50 per share next year (D1).The company’s ROE is 10% and its dividend payout rate is 50%.The current stock price (P0) is \$30 per share.If the firm issues new shares of common stock, they will sell for \$30 per share, but the firm will have to pay flotation expense of 12.5%.Each of the project’s to be taken on has the same degree of risk as the current projects of the firm.What is the WACC of the entire \$9 million to be raised?A.7.81%B.8.41%C.8.21%D.8.61%E.8.01%*Breakdown: Debt = (\$9,000,000)(.35) = \$3,150,00035%Retained Earnings = \$2,700,00030%New Equity = (\$9 - \$3.15 - \$2.7) = \$3,150,000 35%After-tax KD= (6%)(1-.40) = 3.6%KS= 0.03 + (0.05)(1.4) = 10%Alternatively,g = (0.10)(1 – 0.50) = 5%KS= \$1.50 / \$30.00 + 0.05 = 0.05 + 0.05 = 10%Ke= \$1.50 / (\$30.00)(1-0.125) + 0.05 = 10.71%Old Exam Questions - Cost of Capital - SolutionsPage 10 of 42 Pages
Therefore,WACC = (3.6%)(0.35) + (10.0%)(0.30) + (10.71%)(0.35)= 1.26% + 3.0% + 3.7485% = 8.01%9.A firm’s optimal capital structure consists of 35 percent debt, 5 percent preferred stock, and 60 percent common stock. Assume that the firm’s before-tax cost of debt is 7 percent and that its tax rate is 40 percent. Also assume that the firm’s cost of preferred stock is 10 percent and that its weighted average cost of capital is 10.52%. Calculate the firm’s cost of stock (equity).*WACC = (KD)(1-T)(WD) + (KP)(WP) + (KS)(WS)WACC = (.07)(1-.4)(.35) + (.10)(.05) + (KS)(.60) = 10.52%WACC = .0147 + .005 + (KS)(.60) = 10.52%KS= (.1052 - .0147 - .005) / (.60) = .0855 / .60 = 14.25%YOU ARE GIVEN THE FOLLOWING INFORMATION FOR PROBLEMS 10 - 11:Your company's current market-valued capital structure, which is considered to be optimal, is shown below:Debt 30%Preferred Stock 10%Equity 60%In order to meet their expansion plans for next year, the company has decided to raise \$10,000,000. Net Income is expected to be \$1,000,000 next year. However, preferred stock dividends are expected to account for \$100,000 of this profit. The common stock dividend payout rate is 40% of the profit after the payment of preferred dividends. The corporate tax rate is equal to 40%, and the before-tax costsof new financing are estimated to be:Debt: 4% for the first \$2,000,000 of new debt.5% for up to an additional \$1,000,000 of new debt.6% for up to an additional \$1,000,000 of new debt.Preferred:6% for the first \$1,000,000 of new preferred.Old Exam Questions - Cost of Capital - SolutionsPage 11 of 42 Pages
7% for up to an additional \$1,000,000 of new preferred.Equity: 10% for retained earnings.11% for up to the first \$2,000,000 of new common stock. 12% for up to an additional \$2,000,000 of new common stock.13% for up to an additional \$2,000,000 of new common stock.

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