Question

Rollins Corporation is estimating its WACC. It’s current and target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon rate, paid semiannually, a current maturity of 20 years, and sell for $1,040. The firm could sell, at par, $100 preferred stock which pays a $12.00 annual preferred dividend. Rollins' common stock beta is 1.2, and the risk-free rate is 10 percent. Rollins is a constant-growth firm which just paid a dividend of $2.00. Its stock sells for $27.00 per share, and has a growth rate of 3 percent. The floatation cost is 5% for debt, 10% for preferred stock, and 25% for common stock. The firm's marginal tax rate is 40 percent.

Question 1 (worth 15 out of 100 possible points for the quiz)

Part a. Calculate the cost of existing debt.

Part b. Calculate the cost of new debt.

Question 2 (worth 15 out of 100 possible points for the quiz)

Part a. Calculate the cost of existing preferred stock.

Part b. Calculate the cost of new preferred stock.

Question 3 (worth 15 out of 100 possible points for the quiz)

Part a. Calculate the cost of existing common stock.

Part b. Calculate the cost of new common stock.

Question 4 (worth 15 out of 100 possible points for the quiz)

Part a. Calculate the weighted average cost of capital (WACC) for existing capital

Part b. Calculate the weighted average cost of capital (WACC) for new capital

Question 5 (worth 15 out of 100 possible points for the quiz)

Given that the company’s required return (WACC) is 10%, rank the two following projects:

Use only one best method to rank the projects

Project	A	B
Project life	12 years	12 years
Initial investment	$1,200,000	$1,500,000
Annual operating cash flows	$180,000	$225,000

Answer 1

1-	after tax Old cost of debt	[interest+(face value-market value)/period to maturity / (face value+ market value)/2]*(1-tax rate)	[60+(1000-1040)/40 / (1000+1040)/2]*(1-.4)	[59/1020]*(1-.4)
2-	after tax new cost of debt	[interest+(face value-net proceed)/period to maturity / (face value+ net proceeds)/2]*(1-tax rate)	[60+(1000-997.5)/40 / (1000+997.5)]*(1-.4)	[62.5/998.75]*.6
	net proceeds	new issue price*(1-flotation cost)	1050*(1-.05)	997.5
3-	cost of preferred stock-existing	preferred dividend/market price	12/100	12%
4-	cost of preferred stock-new	preferred dividend/(market price-flotation cost)	12/(100-10)	13.33%
5-	cost of common stock-existing	(expected dividend/market price)+growth rate	(2*1.03)/27))+.03	10.63%
6-	cost of common stock-new	(expected dividend/net proceed)+growth rate	(2*1.03)/20.25))+.03	13.17%
	net proceed	market value*(1-flotation cost)	27*(1-.25)	20.25
7-	weighted cost of capital-old
	source	weight	cost	weight*cost
	debt	20%	3.47%	0.006941
	preferred	20%	12%	0.024
	common stock	60%	10.63%	0.063778
	weighted cost of capital-old	sum of weight*cost		9.47%
7-	weighted cost of capital-new
	source	weight	cost	weight*cost
	debt	20%	3.75%	0.007508
	preferred	20%	13%	0.026667
	common stock	60%	13.17%	0.079037
	weighted cost of capital-new	sum of weight*cost		11.32%