Please show all work, this is to help study for an exam tomorrow! RadCo is a ste

Question

Please show all work, this is to help study for an exam tomorrow!

RadCo is a steel manufacturer that finances its operations with 40 percent debt, 10 percent preferred stock, and 50 percent equity. The company‘s cost of debt is 6.88%. The preferred stock pays an annual dividend of $2 and actually sells for $20 per share. The company‘s common stock trades at $30 per share, and its current dividend (D0) of $2 per share is expected to grow at a constant rate of 8% per year.RadCo’s beta is 1.4 and the expected return on the market is 12 percent. The company’s marginal tax rate is 40%.

What is the firm’s after-tax cost of debt?

What is the firm’s cost of preferred stock?

What is the firm’s cost of common stock using the dividend growth approach?

The firm’s financial manager has calculated the cost of the firm’s common stock using the CAPM approach. His calculations showed that cost of equity = 15.20%. What is the corresponding risk-free rate, which was used in his calculation of cost of equity?

What is the firm’s WACC?

Explanation / Answer

Firms After tax cost of debt = before tax rate*(1- marginal tax)

Firms After tax cost of debt = 6.88%*(1- 40%) = 0.0688x0.6 = 4.128% or 4.13%

Firms COst of Preferred Stock = Annual dividend on preferred Stock /Current market price of preferred stock

Firms COst of Preferred Stock = 2/20 = 0.1 OR 10%

Firms Cost of Common Stock = (next year dividend /Current stock price)+Dividend growth rate

Next year dividend = $2 x 8% =2.16

Cost of Equity = (2.16/30)+8% = 0.072+0.08 = 0.152 or 15.2%

Re = rf+(rm-rf)xbeta

15.2% = rf+(12%-rf)x1.4

0.152 = rf+(0.168-1.4rf)

1.4rf-rf = 0.1680- 0.152

rf = 0.016/0.4 = 0.4 or 4%

WACC = 4.13%X40%+10%X10%+15.2%X50%

= 0.01652+1.00+0.076 = 1.092

=

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