Question

Growth Company's current share price is $20.10 and it is expected to pay a $1.30 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 $1.85 per share fixed dividend. If this stock is currently priced at $28.15, what is Growth Company's cost of preferred stock? c. Growth Company has existing debt issued three years ago with a coupon rate of 6.1%. The firm just issued new debt at par with a coupon rate of 6.9%. What is Growth Company's pretax cost of debt? d. Growth Company has 5.1 million common shares outstanding and 1.4 million preferred shares outstanding, and its equity has a total book value of $50.2 million. Its liabilities have a market value of $20.2 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 22% 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. The cost of capital for preferred stock is 6.57%. (Round to two decimal places.) c. Growth Company has existing debt issued three years ago with a coupon rate of 6.1%. The firm just issued new debt at par with a coupon rate of 6.9%. What is Growth Company's cost of debt? (Select from the drop-down menus.) The pre-tax cost of debt is the firm's YTM on current debt. Since the firm recently issued debt at par, then the coupon rate of that debt must be equal to the YTM of the debt. Thus, the pre-tax cost of debt is 6.9% d. Growth Company has 5.1 million common shares outstanding and 1.4 million preferred shares outstanding, and its equity has a total book value of $50.2 million. Its liabilities have a market value of $20.2 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? The market value of assets is $ million (Round to two decimal places.) e. Growth Company faces a 22% tax rate. Given the information in parts (a) through (d), and your answers to those problems, what is Growth Company's WACC? The weighted average cost of capital is %. (Round to two decimal places.)

Answer 1

Part a)

Cost of equity (Ke) = (Expected dividend/current price)+growth rate = (1.3/20.1)+3.6% = 0.06%+3.6% = 4.2%

Part b)

Cost of preferred stock = Fixed dividend/price of the share = 1.85/28.15 = 6.57%

Part c)

Since the firm newly issued debt at coupon rate of 6.9% that will be equal to YTM, hence cost of pretax-debt = YTM = 6.9%

Part d)

Market value of common stock = Shares outstanding*Market price = 5.1million shares*$20.1 = $102.51million

Market value of preferred stock = Shares outstanding*Market price = 1.4million shares*$28.15 = $39.41million

Market value of Growth company's assets = Market value of common stock+Market value of preferred stock+Market value of debt = $102.51million+$39.41million+$20.2million = $162.12million

Part e)

Cost of debt after tax = cost of pretax-debt*(1-tax rate) = 6.9%*(1-0.22) = 6.9%*0.78 = 5.382%

Type	Market value	Cost after tax	WACC (Cost after tax*Market value/ΣMarket value
Common stock	102,510,000	4.20%	2.66%
Preferred stock	39,410,000	6.57%	1.60%
Debt	20,200,000	5.382%	0.67%
	162,120,000		4.92%

WACC = 4.92%