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. Its bonds have a 5 percent coupon, paid semiannually, a current maturity of 12 years, and sell for $876.34.
The firm plans to sell preferred stock at $95 with $10 annual dividend, but flotation costs of 5 percent would be incurred.
Rollins' beta is 1.5, 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 $25.00 and has a growth rate of 8 percent. Flotation cost of 6 percent would be included for issuing additional shares of common stocks.
The firm's policy is to use a risk premium of 6 percentage points when using the bond-yield-plus-risk-premium method to find the cost of equity. The firm's marginal tax rate is 40 percent.

1. What is the cost of debt?

My answer: 3.90%

2. What is the cost of newly issued preferred stock?

3. What is cost of equity based on CAPM, DCF, and Bond Yield + Risk Premium?

4. What is WACC? (Assume cost of equity is the average of cost of equity from three models)

Explanation / Answer

1. FV = $1000, PV = $876.34, Coupon 5% semiannual. So PMT = 5%*1000/2 = 25, nper =12 yrs = 12*2 = 24 period SO YTM= Kd= 2* Rate(nper, PMT,PV,FV) = 2*Rate(24,25,-876.34,1000) = 6.50% So The after-tax cost of debt equals: kd after-tax = Kd*(1 - 0.40) = 6.50%*(1-0.40) = 3.90% 2. Cost of preferred stock: Kp = Pref DIv/Issue price = $10/$95*(1-5%) = 10.00% 3. Cost of common stock (CAPM approach): Ks= Krf+Beta*MRP = 5%+1.5*6% = 14% 4. Using DCF, Ks = D1/(P0-f) + g = D0*(1+8%)/(P0-6%) + 8% For this P0 is needed which is missing. I think u have missed this parameter. SO pl use that value & calculate Ks for DCF 5. Cost of common stock (Bond yield-plus-risk-premium approach): ks = COupon Rate + RP = 5% + 6.0% = 11% 6. WACC = wdkd(1 - T) + wpkp + wsks = 0.2*3.90% + 0.20*10% + 0.6*Ks PL calculte Avge Ks after you find Ks using DCF. Plugin the vale in above eqn to get WACC

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