A A firm has preferred stock outstanding paying a dividend of $6.47 per year, cu

Question

A

A firm has preferred stock outstanding paying a dividend of $6.47 per year, currently trading in the market for $111.1. What is the cost (required return) of the preferred stock? Enter answer in percents.

B

Pidgin Co. is financed 64 percent debt, and the rest with equity. The cost of debt is 5.9%, and the cost of equity is 11.4%. If the firm's marginal tax rate is 33%, what is Pidgin's WACC? Enter answer in percents.

C

wxMaxima Industries just paid an annual dividend of $1.84 a share. The market price of the stock is $24.83 and the firm promises a constant growth rate in dividends of 3.1 percent. What is the firm's cost of equity? (Enter rate in percents, not in decimals.)

Explanation / Answer

Part -A:

The cost of preferred stock = Dividend/Price = 6.47/111.1 = 0.0582 = 5.82%

Part - B

WACC = We * Re + Wd * Rd

We = Weight of equity = 1-0.64 = 0.36

Wd = Weight of debt = 0.64

Re = Cost of equity = 11.4%

Rd = Post tax cost of debt = 5.9*(1-0.33) = 3.953%

Hence WACC = 0.36*11.4 + 0.64*3.953 = 6.63392%

WACC = 6.63%

Part - C

The cost of equity is given by the Dividend distribution model (DDM) as in

Cost of equity =Ke = D1/P0 + g

D1 = dividend next year = 1.84*1.031 = 1.89704

P0 = 24.83

g = 3.1% = 0.031

Cost of equity = Ke = 1.89704/24.83 + 0.031 = 0.1074 = 10.74%

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