Rollins Corporation is estimating its WACC. It\'s current and target capital str

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. Calculate the cost of existing debt and the cost of new debt.

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Nper = 20*2 = 40 (indicates the period over which interest payments are made)

PV = 1040 (indicates the present value of bonds)

FV = 1000 (indicates the face value of bonds)

PMT = 1000*12%*1/2 = 60 (indicates the amount of semi-annual interest payment)

PV = 1040 - 1040*.05 = 988 (indicates the selling price of new debt after floatation cost)

Rate = ? (indicates the cost of new debt)

after Tax Cost of New Debt = Rate(Nper,PMT,PV,FV)*2*(1-Tax Rate) = Rate(40,60,-988,1000)*2*(1-.40) = 7.30%

Answer is 7.30%

Thanks.

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