USE THE FOLLOWING INFORMATION TO ANSWER QUESTIONS 6-13 (5 pts. each) The Ewing D
ID: 2668401 • Letter: U
Question
USE THE FOLLOWING INFORMATION TO ANSWER QUESTIONS 6-13 (5 pts. each)The Ewing Distribution Company (EDC) is planning a $100 million expansion of its chain of discount service stations to several neighboring states. This expansion will be financed with debt, preferred stock and equity. The firm’s has 20,000 bonds with a $1,000 face value of current debt. The debt has a 12% coupon and 20 years remaining before maturity and is currently selling for $865. Ewing’s marginal tax rate is 40%.
EDC has 100,000 shares of $50 par value $3.50 preferred stock outstanding which has a current market price of $42. Ewing’s common stock paid a dividend of $2.10 per share this year and $2.00 the previous year. The current market price per share is $15, and the investment banking firm will charge a flotation fee of 10% if new shares are sold. The current risk-free rate is 7% and the market’s estimated rate of return is 15%. Ewing’s estimated beta is 1.2. Ewing expects to have $20 million of retained earnings available to finance the expansion.
Ewing’s Balance Sheet
Debt $ 20,000,000
Preferred Stock 5,000,000
Common equity 75,000,000
$ 100,000,000
9. Compute the cost of retained earnings : CAPM
Explanation / Answer
9. Computing the cost of retained earnings using CAPM: According to CApital Asset Pricing model, Re = Rf + Beta [Rm - Rf] where Rf is the risk free rate of return = 7% beta is the risk co-efficient = 1.2 Rm is the market return = 15% Re is the cost of retained earnings Substituting the values in the above equation, we get Re = 0.07 + 1.2 [0.15 - 0.07] = 0.07 + 1.2 (0.08) = 0.07 + 0.096 = 0.166 or 16.6% Therefore, the value of cost of retained earnings using CAPM is 16.6%Related Questions
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