33:390:310 Lecture Notes - Lecture 14: Preferred Stock, Weighted Arithmetic Mean, Capital Structure

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rubysalmon273

3 Nov 2017

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Chapter 14: cost of capital the dividend growth model approach: p0= d1/(re-g) Advantages and disadvantages of dividend growth model: advantage, easy to use and understand, disadvantages, does not consider risk, does not work if there is no dividend, does not work if there is no steady growth. The sml approach: expected return = (risk free rate) + (beta) x (market risk premium) Cost of preffered stock: rp = d/p0, preferred stock generally pays a constant dividend each period, dividends are expected to be paid every period forever, preferred stock is a perpetuity. The weighted average cost of capital: we can use the individual costs of capital that we have computed to get our average cost. Capital structure weights: e= market value of equity (# of outstanding shares * price per share, d= market value of debt (outstanding # of bonds * price per bond, v= value of the firm = debt + equity.

Related Questions

Please answer ALL of these questions. It would really help me out! Thanks!

1. MV corporation has debt with Market value of $100 million, common equity with a book value of $100 million, and preferred stock woth $20 million outstanding. It's common equity trades at $50 per share, and the firm has 6 million shares outstanding. What weights should MV corporation use in its WACC

2. Book co. has 1.5 million shares of common stock equity with a par (book) value of $1.40, retained earnings of $28.1 million, and its shares have a market value of $51.74 per share. it also has debt with a par value of $19.1 million that is trading at 104% of par.

a. What is the market value of its equity?

b. What is the market value of its debt?

c. What weights should it use in computing its WACC?

3. Avicorp has a $10 million debt issue outstanding, with a 6% coupon rate. The debt has semiannual coupons, the next coupon is due in six months, and the debt matures in five years. It is currently priced at 95% of par value.

(a) What is Avicorpâs pretax cost of debt?

(b) If Avicor faces a 40% tax rate, what is its after-tax cost of debt? The after-tax cost of debt for Avicor is:

4. Dewyco has preferred stock trading at $50 per share. The next preferred dividend of $4 is due in one year. What is Dewycoâs cost of capital for preferred stock?

5. Steady Company's stock has a beta of 0.24. If the risk-free rate is 5.8% and the market risk premium is 7.1%, what is an estimate of Steady Company's cost of equity?

(round to one decimal place)

6. HighGrowth Company has a stock price of $20. The firm will pay a dividend of $1 next year, and its divident is expected to grow at a rate of 4% per year thereafter. What is your estimate of HighGrowth's cost of equity capital?

7. CoffeeCarts has a cost of equity of 15%, an effective cost of debt of 4%, and it's financed 70% with equity and 30% with debt. What is this firm's WACC?

8. AllCity Inc is financed 40% with debt, 10% with preferred stock, and 50% with common stock. Its pretax cost of debt is 6%. Its preferred stock pays an annual dividend of $2.50 and is priced at $30. It has an equity beta of 1.1. Assume the risk-free rate is 2%, the market risk premium is 7% and AllCity's tax rate is 35%. What is its after-tax WACC?

9. Growth company's current share price is $20 and is expected to pay a $1 dicidend per share next year. After that, the firm's dividends are expected to grow at a rate of 4% per year.

Growth company has existing debt issued three years ago with a coupon rate of 6%. The firm just issued new debt at a par with a coupon rate of 6.5%.

a. What is Growth Company's pre-tax cost of debt?

b. Growth Company also has preferred stock outstanding that pays $2 per share fixed dividend. If the stock is currently price at $28, what is Growth Company's cost of preffered stock?

c. Growth Company has existing debt issued three years ago with a coupon rate of 6%. The firm just issued new debt at par with a coupon rate of 6.5%. What is Growth Company's pretax cost of debt?

d. Growth Company has 5 million common shares outstanding and 1 million preferred shares outstanding, at its total book value is $50 million. Its liabilitities have a market value of $20 million. If Growth Company's common and preferred shares priced as in parts a and b, what is the market value of Growth Company's assets?

e. Growth Company faces a 35% tax rate. Given the information in parts a through d, and your answers to those problems, what is Growth Company's WACC?

10. A retail coffee company is planning to open 100 new coffee outlets that are expected to generate, in total, $15 million in free cash flows per year, with a growth rate of 3% in perpetuity. If the coffee companyâs WACC is 10%, what is the NPV of this expansion?

The major components that determine the risk premium on a specific security at any point in time include all of the following except

interest rate risk

business risk

financial risk

real rate of return risk

If a firm sells assets, generating cash flows, the cost of these funds is ____.

the firm's cost of cash flows

the firm's weighted cost of capital

zero

the firm's cost of equity

Which of the following statements (if any) is (are) true concerning companies that do not pay dividends?

The cost of equity capital cannot be determined by using the CAPM, the risk premium on debt approach, or by estimating ke for comparable dividend-paying stocks in their industry.

The dividend capitalization model can be used to determine an accurate cost of equity capital.

The cost of equity capital is equal to the growth short-term rate of earnings per share.

The cost of equity capital can be estimated using the Capital Asset Pricing Model.

1. The firms tax rate is 40%
2. The current price of Colemans 12% coupon, semiannual payment,noncallable bonds with 15 years remaining to maturity is $ 1153.72.Coleman does not use short term interest bearing debt on apermanent basis. new bonds would be privately placed with noflotation cost.
3. the current price of the firms 10 % $100.00 par value, quarterlydividend, prepetual preffered stock is $111.10
4. Colemans current stock is selling for $50 per share. Its lastdividend was $4.19 and dividends are expected to grow at a constantrate of 5% in the forseeable future. Colemans beta is 1.2, theyield on T Bonds is 7% and the market risk premium is estimated tobe 6%. For the bond yield plus risk premium approach, the firm usesa risk premium of 4%.

A. 1- What sources of capital should be included when you estimatethe WACC?
2- Should the component costs be figured on a before tax or anafter tax basis?
3- Should the costs be historical costs or new costs?

B- what is the market intreest rate on colemans debt and itscomponent cost of debt

c- 1- what is the firms cost of preffered stock?

d- 1- why is there a cost associated with retained earnings?
2- what is colemans estimated cost of common equity using the CAPMapproach?

33:390:310 Lecture Notes - Lecture 14: Preferred Stock, Weighted Arithmetic Mean, Capital Structure

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