Rollins Corporation is estimating its WACC. Its target capital structure is 20 p

Question

Rollins Corporation is estimating its WACC. Its target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Rollins' beta is 1.4 , the risk-free rate is 5 percent, and the market risk premium is 6 percent. Rollins is a constant-growth firm which just paid a dividend of $2.00, sells for $ 34 per share, and has a growth rate of 5 percent. The firm's policy is to use a risk premium of 5 percentage points when using the bond-yield-plus-risk-premium method to find rs. The firm's marginal tax rate is 40 percent. What is Rollins cost of equity when using the CAPM approach? Express your answer in percentage (without the % sign) and round it to two decimal places.

Explanation / Answer

The correct answer is 7.2%

Explanation :- Since the bond sells at par of $1,000, its YTM and coupon rate (12 percent)

are equal. Thus, the before-tax cost of debt to Rollins is 12.0 percent. The

after-tax cost of debt equals

                 kd,After-tax = 12.0%(1 - 0.40) = 7.2%.

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