Gao's preferred stock pays a dividend of $3.30 per share, and new preferred could be sold at a price to net the company $30 per share.
Security analysts are projecting that the common dividend will grow at a rate of 7% a year.
The firm can also issue additional long-term debt at an interest rate (or before-tax cost) of 10%, and its marginal tax rate is 35%.
The market risk premium is 6%, the risk free rate is 6.5%, and Gao's beta is 0.83.
In its cost-of-capital calculations, Gao uses a target capital structure with 45% debt, 5% preferred stock, and 50% common equity
a. Calculate the cost of each capital component, i.e., the after-tax cost of debt, the cost of preferred stock (including flotation costs), the cost of equity (ignoring flotation costs) with the DCF method and the CAPM method.
b. Calculate the cost of new stock using the DCF model.
c. What is the cost of new common stock, based on the CAPM? (Find the difference between ke and ks as determined by the DCF method, and add that differential to the CAPM value for ks.
d. Using the target capital structure for Gao Computer and assuming that it will not issue new equity, will continue to use the same capital structure, what is the WACC?
This question was asked on Jan 27, 2014.
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