Question

Growth Company's current share price is $20.00 and it is expected to pay a $1.05 dividend per share next year. After that, the firm's dividends are expected to grow at a rate of 3.6% per year. a. What is an estimate of Growth Company's cost of equity? b. Growth Company also has preferred stock outstanding that pays a $1.90 per share fixed dividend. If this stock is currently priced at $28.25, what is Growth Company's cost of preferred stock? c. Growth Company has existing debt issued three years ago with a coupon rate of 5.7%. The firm just issued new debt at par with a coupon rate of 6.7%. What is Growth Company's cost of debt? d. Growth Company has 5.2 million common shares outstanding and 1.1 million preferred shares outstanding, and its equity has a total book value of $50.1 million. Its liabilities have a market value of $20.4 million. If Growth Company's common and preferred shares are priced as in parts (a) and (b), what is the market value of Growth Company's assets? e. Growth Company faces a 40% tax rate. Given the information in parts (a) through (d), and your answers to those problems, what is Growth Company's WACC? Note: Assume that the firm will always be able to utilize its full interest tax shield.

Answer 1

a

Cost of equity

As per DDM

Price= Dividend in 1 year/(cost of equity - growth rate)

20 = 1.5/ (Cost of equity - 0.036)

Cost of equity% = 11.1

b

cost of preferred equity

cost of preferred equity = Preferred dividend/price*100

cost of preferred equity = 1.9/(28.25)*100

=6.73

c

Cost od debt = 6.7%

d

Total Capital value = price of Equity*Shares of Equity + price of Preferred equity*Shares of Preferred equity+MV of liabilities

=20*5200000+28.25*1100000+20400000

= 155475000

e

Weight of Equity = Value of Equity/Total Capital Value

= 104000000/155475000

=0.6689

Weight of Preferred equity = Value of Preferred equity/Total Capital Value

= 31075000/155475000

=0.1999

Weight of Liabilities = Value of Liabilities/Total Capital Value

= 20400000/155475000

=0.1312

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 6.7*(1-0.4)

= 4.02

WACC=after tax cost of debt*W(D)+cost of equity*W(E)+Cost of preferred equity*W(PE)

WACC=4.02*0.1312+11.1*0.6689+6.73*0.1999

WACC =9.3%