Please provide step-by-step answer with formulas. Rollins Corporation is estimat

Question

Please provide step-by-step answer with formulas. Rollins Corporation is estimating its WACC. Its target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sell for $1,000. The firm could sell, at par, $100 preferred stock which pays a 12 percent annual dividend, but flotation costs of 5 percent would be incurred. Rollins' beta is 1.2, the risk-free rate is 10 percent, and the market risk premium is 5 percent. Rollins is a constant-growth firm which just paid a dividend of $2.00, sells for $27.00 per share, and has a growth rate of 8 percent. The firm's policy is to use a risk premium of 4 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 Firm's WACC?

Explanation / Answer

Step 1. find Rd

The bonds are sold at par value

therefore, Rd = coupon rate = 12%

Step 2.find the cost of preferred stock

cost of preferred stock = 12%/(1-5%) = 12.63%

Step 3.find Rs

1)using CAPM

Rs = Rf + beta*market risk premium = 10% + 1.2*5% = 16%

2)using dividened growth model

Rs = D0*(1+g)/P + g = 2*(1+8%)/27 + 8% = 16%

3) using the bond-yield-plus-risk-premium method

Rs = bond yield + risk premium = 12% + 4% = 16%

Therefore, Rs = 16%

Step 4. find WACC

WACC = 12%*20% + 12.63%*20% + 16%*60% = 14.53%

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