M12-22. Estimating Weighted Average Cost of Capital. Assume that a company has $
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Question
M12-22. Estimating Weighted Average Cost of Capital. Assume that a company has $1 billion in preferred stock and $3 billion in common stock. Also, it pays 6% dividends on preferred stock and its cost of equity capital is 7%. The company has no debt. Compute the company’s WACC.
M12-23. Estimating Company Value Using DDM with Constant Perpetuity. Assume that a company’s dividends per share are projected to remain at $1.20 each year, and that its cost of equity capital is 5%. Estimate the company’s per share stock price.
M12-25. Estimating Company Value Using DDM with Increasing Perpetuity. Assume that a company’s dividends per share are projected to grow at 2% each year, its next year’s dividends per share is $1.20, and its cost of equity capital is 5%. Estimate the company’s per share stock price.
M12-26. Estimating Company Value Using DDM with Increasing Perpetuity. Assume that a company paid $1.20 dividend per common share, its dividend per share is expected to grow at a constant rate of 2%, and its cost of equity capital is 5%. Estimate the company’s per share stock price.
Explanation / Answer
M12-22.
Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is proportionately weighted. All sources of capital, including common stock, preferred stock, and bonds are included in a WACC calculation.
WACC = (E/(E+D+P))*re+(D/(E+D+P))*(1-t)*rd+(P/(E+D+P))*rp
E = Market value of equity
D = Market value of debt
P = Market value of preferred stock
re = Cost of equity
rd = Cost of debt
rp = Cost of preferred stock
t = Marginal tax rate
Since company has no debt, second component in the above formula will be zero.
WACC = (3/(3+0+1))*7%+(1/(3+0+1))*6% =0.0525+0.015 = $ 0.0675 billion = $67.5 million
M12-23
Dividend Discount Model (DDM) with constant perpetuity is same as Gordon Growth model formula
Company’s per share stock price (P) = D/(r-g)
Where
D – Dividend per share
r- Cost of Equity
g – growth rate
Growth rate is zero for the constant perpetuity
P = 1.2/(5%-0) = $24
M12-26
Next year’s dividends per share = $1.2
AS the dividend increases by 2%, the above dividend has increased by 2% compared to the current year
Current year dividend per share = 1.2/(1+2%) = 1.1765
Using the above formula
Company’s per share stock price (P) = D/(r-g)
P = 1.1765/(5%-2%) = 1.1765/3% = $39.217
M12-26
Using the above formula
Company’s per share stock price (P) = D/(r-g)
P = 1.2/(5%-2%) = 1.2/3% = $40
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