Question

Jarett & Sons's common stock currently trades at $23.00 a share. It is expected to pay an annual dividend of $2.25 a share at the end of the year (D₁ = $2.25), and the constant growth rate is 8% a year.

1. What is the company's cost of common equity if all of its equity comes from retained earnings? Do not round intermediate calculations. Round your answer to two decimal places.

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2. If the company issued new stock, it would incur a 10% flotation cost. What would be the cost of equity from new stock? Do not round intermediate calculations. Round your answer to two decimal places.

The firm's target capital structure is the mix of debt, preferred stock, and common equity the firm plans to raise funds for its future projects. The target proportions of debt, preferred stock, and common equity, along with the cost of these components, are used to calculate the firm's weighted average cost of capital (WACC). If the firm will not have to issue new common stock, then the cost of retained earnings is used in the firm's WACC calculation. However, if the firm will have to issue new common stock, the cost of new common stock should be used in the firm's WACC calculation.

Quantitative Problem: Barton Industries expects that its target capital structure for raising funds in the future for its capital budget will consist of 40% debt, 5% preferred stock, and 55% common equity. Note that the firm's marginal tax rate is 25%. Assume that the firm's cost of debt, r_d, is 10.2%, the firm's cost of preferred stock, r_p, is 9.4% and the firm's cost of equity is 12.8% for old equity, r_s, and 13.2% for new equity, r_e. What is the firm's weighted average cost of capital (WACC₁) if it uses retained earnings as its source of common equity? Do not round intermediate calculations. Round your answer to two decimal places.

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What is the firm’s weighted average cost of capital (WACC₂) if it has to issue new common stock? Do not round intermediate calculations. Round your answer to two decimal places.

  

Answer 1

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ke - Microsoft Excel (Product Activation Failed) Add-Ins - 2x General Wrap Text Merge & Center $ - % 8.9 Σ AutoSum : A Fill Sort & 2 Clear Filter Editing Formatting as Table Styles Styles Find & Select Number Cells C D CE CF CG CH CI CJ CK File Home Insert Page Layout Formulas Data Review View % Cut Calibri -11AA = = = Dr Ea Copy Paste BI U DA Format Painter * Clipboard Font Alignment CB746 CA СВ CC 731 732 733 734 COST OF RETAINED EARNINGS 735 kr = D1/PO+g 736 a kr = 2.25/23 +0.08 = 17.78% 737 738 COST OF EQUITY 739 ke = D1/(PO(1-f)) +g 740 b kr = 2.25/(23(1-0.10)) + 0.08 = 18.87% 741 742 743 744 745 746 747 748 749 750 751 HI convexity DGM betaport future INDEX INTL CAP BUD SANDRINE LEASING PV, FV, ANNUITY DIR right clean RI K E CAPM UTILITY, SHARPE, beta ferences: A1310 O -_+ Rea YIELD bond portfolio WACC BO! 120% - 9 * * 10 ENG 2. 30-11-2019

ke - Microsoft Excel (Product Activation Failed) Add-Ins View - 2x Σ AutoSum : A Dr General Autosum. I File Home Insert Page Layout Formulas Data Review % Cut Calibri -11AA = = = Ea Copy Paste BI U DA * Format Painter Clipboard Font CG742 Wrap Text Merge Merge & Center Center onda SF 4:0 .00 8.9 Insert Delete Format $ - % % Number Conditional Format Formatting as Table Styles Fill 2 Clear Cell Styles Sort & Filter Editing Find & Select Alignment Cells CA CB CC Formula Bar CE CE CG CH CI CJ CK BARTON AFTER TAX COST OF DEBT = 10.2%*(1-0.25) = 7.65% WACC BASED ON RETAINED EARNINGS SOURCE WEIGHT 40% DEBT PREFERRED STOCK COMMON EQUITY COC (%) WEIGHTED COST (%) B A*B 7.65% 3.06% 9.40% 0.47% 12.80% 7.04% WACC = 10.57% 5% 55% 741 742 743 744 745 746 747 748 749 750 751 752 753 754 755 756 757 758 759 760 761 HI WACC BASED ON NEW COMMON STOCK SOURCE WEIGHT DEBT PREFERRED STOCK COMMON EQUITY 40% 5% 55% COC (%) WEIGHTED COST (%) BA*B 7.65% 3.06% 9.40% 0.47% 13.20% 7.26% WACC = 10.79% convexity DGM betaport future INDEX INTL CAP BUD SANDRINE LEASING PV, FV, ANNUITY DIR right clean RI K E CAPM UTILITY, SHARPE, beta ferences: A1310 O -_+ Rea YIELD bond portfolio WACC BO! 120% - 9 * * 10 ENG 2. 30-11-2019