Question

Javits & Sons' common stock currently trades at $33.00 a share. It is expected to pay an annual dividend of $1.25 a share at the end of the year (D1 = $1.25), and the constant growth rate is 4% a year.

A) What is the company's cost of common equity if all of its equity comes from retained earnings? Round your answer to two decimal places. %

B) If the company were to issue new stock, it would incur a 12% flotation cost. What would the cost of equity from new stock be? Round your answer to two decimal places. %

The Patrick Company's year-end balance sheet is shown below. Its cost of common equity is 17%, its before-tax cost of debt is 12%, and its marginal tax rate is 40%. Assume that the firm's long-term debt sells at par value. The firm’s total debt, which is the sum of the company’s short-term debt and long-term debt, equals $1,191. The firm has 576 shares of common stock outstanding that sell for $4.00 per share. Calculate Patrick's WACC using market value weights. Round your answer to two decimal places. %

Assets			Liabilities And Equity
Cash	$ 120		Accounts payable and accruals	$ 10
Accounts receivable	240		Short-term debt	51
Inventories	360		Long-term debt	$1,140
Plant and equipment, net	2,160		Common equity	1,679
Total assets	$2,880		Total liabilities and equity	$2,880

Adams Corporation is considering four average-risk projects with the following costs and rates of return: Project Cost Expected Rate of Return 1 $2,000 16.00% 2 3,000 15.00 3 5,000 13.75 4 2,000 12.50 The company estimates that it can issue debt at a rate of rd = 10%, and its tax rate is 35%. It can issue preferred stock that pays a constant dividend of $3 per year at $53 per share. Also, its common stock currently sells for $33 per share; the next expected dividend, D1, is $3.50; and the dividend is expected to grow at a constant rate of 6% per year. The target capital structure consists of 75% common stock, 15% debt, and 10% preferred stock. What is the cost of each of the capital components? Round your answers to two decimal places. Cost of debt % Cost of preferred stock % Cost of retained earnings % What is Adams' WACC? Round your answer to two decimal places. % Only projects with expected returns that exceed WACC will be accepted. Which projects should Adams accept? Project 1 -Select-acceptreject Project 2 -Select-acceptreject Project 3 -Select-acceptreject Project 4 -Select-acceptreject

Answer 1

Solution: 01 rs=(D1/PO)+g rs=(1.25/33)+0.04 rs= 7.79% PO= market value per share rs = cost of internal equity g= growth rate D1=dividend at the end of year 1 F= Floatation cost re=(D1/PO)+g re=(1.25/(33-33*0.12)+0.04 re= 8.30%

Q2 Financing Debt Equity Market value Market weight after tax cost of capital weighted cost b=a/3495 d=b*c 1191 0.34077 7.20% y 2.45% 2304 x 0.65923 17.00% 11.21% 3495 WACC 13.66% working: x=576*4 y=12%*(1-0.4) 2304 7.20%

Q3 after tax cost of debt (rd) =0.1*(1-0.35) 6.50% cost of preferred stock = rp= Dividend/current price = 3/53 | 5.66% cost of retained earning = rs =(D1/PO) + g =(3.5/33) + 0.06 16.61% WACC=rd*wd+rp* wp+rs*ws WACC = 0.065 *0.15 + 0.0566*0.1+0.1661*0.75 14.00% Which projects should Adamson accept? Project accept as expected return is more than WACC. accept as expected return is more than WACC. reject as expected return is less than WACC. reject as expected return is less than WACC. 3 I