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    FAP T11 Kuralay

    Uploaded by

    Kuralay Tilegen
    The document contains 8 examples calculating costs of equity, preferred stock, and debt for various companies using the dividend growth model, CAPM, and bond pricing models. The weighted average cost of capital (WACC) is calculated for one company with a target capital structure of 70% equity, 5% preferred stock, and 25% debt. The president is told that debt is preferred over preferred stock for the capital structure because the after-tax cost of debt is lower than the cost of preferred stock.

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    FAP T11 Kuralay

    Uploaded by

    Kuralay Tilegen
    263 views5 pages
    The document contains 8 examples calculating costs of equity, preferred stock, and debt for various companies using the dividend growth model, CAPM, and bond pricing models. The weighted average cost of capital (WACC) is calculated for one company with a target capital structure of 70% equity, 5% preferred stock, and 25% debt. The president is told that debt is preferred over preferred stock for the capital structure because the after-tax cost of debt is lower than the cost of preferred stock.

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    The document contains 8 examples calculating costs of equity, preferred stock, and debt for various companies using the dividend growth model, CAPM, and bond pricing models. The weighted average cost of capital (WACC) is calculated for one company with a target capital structure of 70% equity, 5% preferred stock, and 25% debt. The president is told that debt is preferred over preferred stock for the capital structure because the after-tax cost of debt is lower than the cost of preferred stock.

    Copyright:

    © All Rights Reserved
    Download as XLSX, PDF, TXT or read online from Scribd
    Download as xlsx, pdf, or txt
    263 views5 pages

    FAP T11 Kuralay

    Uploaded by

    Kuralay Tilegen
    The document contains 8 examples calculating costs of equity, preferred stock, and debt for various companies using the dividend growth model, CAPM, and bond pricing models. The weighted average cost of capital (WACC) is calculated for one company with a target capital structure of 70% equity, 5% preferred stock, and 25% debt. The president is told that debt is preferred over preferred stock for the capital structure because the after-tax cost of debt is lower than the cost of preferred stock.

    Copyright:

    © All Rights Reserved
    Download as XLSX, PDF, TXT or read online from Scribd
    Download as xlsx, pdf, or txt
    of 5
    At a glance
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    The document discusses several methods for calculating a company's cost of equity and weighted average cost of capital (WACC), including the dividend growth model, capital asset pricing model, and using the costs of different sources of capital.

    To calculate a company's cost of equity using the dividend growth model, you would take the most recent dividend per share, the expected long-term dividend growth rate, and the current stock price and plug them into the dividend growth model formula.

    To calculate a company's WACC, you need the costs of equity, preferred stock, and debt (both pre-tax and post-tax costs), the weights of each source of financing in the target capital structure, and the corporate tax rate.

    1

    The Tribiani Co. just issued a dividend of $2.90 per share on its
    common stock. The company is expected to maintain a constant
    4.5 percent growth rate in its dividends indefinitely. If the stock
    sells for $56 a share, what is the company’s cost of equity?

    use DDM (Dividend growth model)


    r=(D0 x (1+g) / P) + g
    re 9.91%

    2
    The Swanson Corporation’s common stock has a beta of 1.07. If
    the risk-free rate is 3.4 percent and the expected return on the
    market is 11 percent, what is the company’s cost of equity capital?

    use CAPM
    R e = rf + B x (Rm-rf) 11.53%

    3
    Stock in Jansen Industries has a beta of 1.05. The market risk
    premium is 7 percent, and T-bills are currently yielding 3.5
    percent. The company’s most recent dividend was $2.45 per share,
    and dividends are expected to grow at an annual rate of 4.1
    percent indefinitely. If the stock sells for $44 per share, what is
    your best estimate of the company’s cost of equity?

    use both DDM and CAPM


    R e (DDM) 9.90%
    R e (CAPM) 10.85%
    average 10.37%
    4
    Suppose Wacken, Ltd., just issued a dividend of $2.73 per share on
    its common stock. The company paid dividends of $2.31, $2.39,
    $2.48, and $2.58 per share in the last four years. If the stock
    currently sells for $43, what is your best estimate of the
    company’s cost of equity capital using the arithmetic average
    growth rate in dividends? What if you use the geometric average
    growth rate?

    Divident 1 2.73
    growth
    year1 2.31
    year2 2.39 0.03463203
    year3 2.48 0.0376569
    year4 2.58 0.04032258
    P0 43
    Cost of equity Re using arithmetic 0.10102555
    Re using geometric 0.10095319
    arithmetic growth rate 0.03753717
    geometric growth rate 0.03746482

    5
    Savers has an issue of preferred stock with a stated dividend of
    $3.85 that just sold for $87 per share. What is the bank’s cost of
    preferred stock?

    D 3.85
    P0 87
    The cost of preferred stock=D/P0 0.04425287

    6
    Sunrise, Inc., is trying to determine its cost of debt. The firm has a
    debt issue outstanding with 23 years to maturity that is quoted at
    96 percent of face value. The issue makes semiannual payments
    and has an embedded cost of 5 percent annually. What is the
    company’s pretax cost of debt? If the tax rate is 21 percent, what
    is the aftertax cost of debt?

    maturity (years) 23
    face value 96.00%
    embedded cost paid annually 5.00%
    Pretax cost of debt (Rd)
    tax rate 21.00%
    after tax cost of debt Rd
    coupon payment 25
    periodic interest rate 0.025
    market value 960
    number of periods 46
    the yield maturilty 0.02551043
    the annual pretax rate 0.05102086
    after tax cost of debt 0.04030648
    7
    Jiminy’s Cricket Farm issued a 30-year, 4.5 percent semiannual
    bond three years ago. The bond currently sells for 104 percent of
    its face value. The company’s tax rate is 22 percent.

    a. What is the pretax cost of debt? 0.02140523


    b. What is the aftertax cost of debt? 0.01669608
    c. Which is more relevant, the pretax or the aftertax cost of debt? Why?

    time 30
    semmiannual bond 4.50%
    face value 104% 1040
    tax rate 22%

    8
    Ninecent Corporation has a target capital structure of 70 percent
    common stock, 5 percent preferred stock, and 25 percent debt. Its
    cost of equity is 11 percent, the cost of preferred stock is 5
    percent, and the pretax cost of debt is 6 percent. The relevant tax
    rate is 23 percent.

    a. What is the company’s WACC? (Weighted average cost of capital) 0.09405


    b. The company president has approached you about the
    company’s capital structure. He wants to know why the company
    doesn’t use more preferred stock financing because it costs less
    than debt. What would you tell the president?
    the effective cost of debt is lower than the 5
    Common stock 70.00%
    Preffered tock 5.00%
    Debt 25.00%
    Cost of equity (Re) 11.00%
    Cost of preferred stock → Rp = D/P0 5.00%
    Pretax cost of debt (Rd) 6.00%
    relevant tax rate 23.00%
    after tax cost of debt Rd 5.9862
    number of periods 60
    coupon pmt 22.5

    st of debt is lower than the 5% of preferred stock so here you would actually want the debt.

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