The purpase of this assignment is to solidify your understanding on the applicat
ID: 2783507 • Letter: T
Question
The purpase of this assignment is to solidify your understanding on the applications of the cost of capital topics. The scores of this assignment will help in assessing theolwing leaning goall of the course:-tudents successfully completing this course will be able to estate and mterpret he cost of capital of a firm based on different capital structures. You are required to use a financial calculator or spreadsheet (Excel) to solve 10 problem provided on page 3) related to the cost of capital. You are required to show the following 3 steps for each problem (sample questions and solutions are peovided for guidance (i) Describe and interpret the assur ions related to the problem (a) Apply the appropeiate mathematical model to solve the problem iil) Calculate the correct solution to the problem Sample Questions and Selutions Sample Qwestion A company is expected to pay a $3.50 dividend at year-end, the dividends are expected to grow al a constant rate of 6son, a year. and the commm ock curesty sells for $1250 a share. The before-tax cost of debt is 7.50%. and the tax talEs 40%-The upd cap tal structure cosasts of 40% debt and 60% comnwn cquity. Wha she company's WACC ifall earnings? equty s tom retained Solution (i) problem assumes the stock will have a constant poaá of 65% fnner. The constant growth model is appropeiate to use for solution depends on the correctness of the constant growth assumption The cost of equity assumes there will not be any new stock issuance. Therefore, the cost of equity is the cost of retained carnings for the existing sharcholders The cost of debt should be on afler-tax basis duc to the tax shield peovided by the interest expense this problem The accuracy of the (ii The cost of equity is based on the following K-D+ P is the current price to · D, is th' next period's dividend. * R is the required return on this slock be calculatied. g is the constant growth The cost of debt is based onks-1-T rd is the beforo-tax cost of debe . T is the tax rate The WACC is based on: WACC-wk-w ) Cost of retained earnings-(3.5625) + 0.065-0.121 or 12.1% Cost ofdebt-7.5 x (1-0.4)-45% WACC-104x4. 5) + (16121)-906 % The average cost of capital for this compamy based on thei euang debt and equity is 9.06%Explanation / Answer
Solution 4:
Given that Current selling price, P = 22, Last dividend, D = 1.20, Growth rate, g = 6% and floatation cost, F = 5%
The cost of new common stock, ke is
ke = D (1 + g)/P0 (1 – F) + g
ke = 1.20 (1.06)/22(1 – 0.05) + 0.06
ke = 0.0609 + 0.06
ke = 0.1209 or 12.09%
Solution 5:
Given that weight of debt, wd = 0.4, weight of equity, we = 0.6, tax rate, t = 40%, Cost of debt, kd = 7.5% and cost of equity, ke = 15%
The firm’s WACC is
WACC = wd*kd*(1 – t) + we*ke
WACC = 0.4*7.5%*(1 – 0.4) + 0.6*15%
WACC = 10.8%
Solution 6:
Given that expected dividend, D1 = $3, Current price, P0 = $60, Floatation cost, F = $3 and growth rate, g = 8%
The cost of common equity, ke is
ke = D1/(P0 – F) + g
ke = 3/(60- 3) + 0.08
ke = 0.1326 or 13.26%
Solution 7:
Given that selling price, P0 = $28, Annual dividend, D = $2 and Floatation cost, F = $3
The cost of new preferred stock, kp is
Kp = D/(P0 – F)
Kp = 2/(28 – 3)
Kp = 0.08 or 8%
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