Question

Growth​ Company's current share price is $ 20.25 and it is expected to pay a $ 0.95 dividend per share next year. After​ that, the​ firm's dividends are expected to grow at a rate of 3.9 % per year.

Growth Company's current share price is $20.25 and it is expected to pay a $0.95 d dend per share next year. After that the firm's d dends are expected to row at a rate of 39% per year. a. What is an estimate of Growth Company's cost of equity? b. Growth Company also has preference shares outstanding that pay a $1.95 fixed dividend. If these shares are currently priced at $28.20, what is Growth Company's cost of preference shares? c. Growth Company has existing debt issued three years ago with a coupon rate of 5.5%. The firm ust issued new debt at par with a coupon rate of 6.6%. What is Growth Company's pre-tax cost of debt? d. Growth Company has 5.3 million ordinary shares outstanding and 1.5 million preference shares outstanding, and its equity has a total book value of $49.9 million. Its liabilities have a market value of $19.5 milion. If Growth Company's ordinary and preference shares are 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 d, and your answers to those problems, what is Growth Company's ACC a. The required return (cost of capital) of levered equity is 8.59 %. (Round to two decimal places.) b. The cost of capital for preference shares is 6.91 %. (Round to two decimal places.) C. The pre-tax cost of debt is the firm's YTM on current debt. Since the firm recentty issued debt at par, then the coupon rate of that debt must be equal to d. The market value of assets is s million. (Round to two decimal places.) the YTM of the debt. Thus, the pre-tax cost of debt is 6.6%

Answer 1

a). Cost of equity = Next year's dividend/current share price + growth rate

= (0.95/20.25) + 3.9% = 8.59%

b). Cost of preference shares = dividend/share price = 1.95/28.20 = 6.91%

c). The debt is issued at par so the coupon rate is equal to the YTM. So, pre-tax cost of debt is the YTM which is 6.6%

d). Market value (MV) of a levered firm = MVdebt + MVcommon + MVpreference

MV of debt = MV of liabilities = 19,5 million

MV of common stock = share price*shares O/S = 20.25*5.3 = 107.33 million

MV of preference shares = share price*shares O/S = 28.20*1.5 = 42.30 million

MV of the levered firm = 19.5 + 107.33 + 42.30 = 169.13 million

MV of assets = 169.13 million

e). WACC = 7.64%

	MV (million)	Weight (MV/Total)	Cost	Weighted cost (weight*cost)
Debt	19.50	0.12	3.96%	0.46%
Common stock	107.33	0.63	8.59%	5.45%
Preference shares	42.30	0.25	6.91%	1.73%
Total	169.13		WACC	7.64%