dl Use the following information for questions 1, 2, and 3. Rollins Corporation

Question

dl Use the following information for questions 1, 2, and 3. Rollins Corporation is estimating its WACC. It's current and target capital structure is percent debt and 60 percent common equity. Its bonds have a 12 percent coupon, pa 40 , paid annually, a current maturity of 20 years, and sell for $1,040. Rollins' beta is 1.2, and Rollins is a constant-growth firm which just paid a dividend The of $2.00. Its stock sells for $27.00 per share, and has a growth rate of 8 percent. firm's marginal tax rate is 40 percent T Show all work for credit Question 1) What is Rollins' cost of debt (also known as YTM, rd, or ka)? Input N-40; PV=-1040, PMT-60; FV=1000 Output 1= 5.74% 1-5.74%-k d/2 kd= 5.74% x 2=11.5% cost ot existing dew kd (1-T)-1 1.5%(0.6)-6.9% cost of new debt . D - Question 2) what is Rollins' cost ofcommon stock (also known as-ork)? Costet Ks D1/Po +g 2/27+0.08 exin PP T cost new D1 is the dividend paid in the first quarter 0 is the price of the stock is the growth rate of the stock 2t (1 uestion 3) hat is Rollins' weighted average cost capital WACC? CE(PM ACC= Waka (1-T) + W,kp + Wake

Explanation / Answer

1) Cost of debt = Coupon + (face value - price )/ maturity /  {(face value + price )/ 2}

= ($1000 * 12%) + (1000 -1040)/20 /  {(1000 + 1040 )/ 2}

= [120 - 2] /  {2040 / 2}

= [120 - 2] / 1020

= 118 / 1020

= 11.5%

Cost of debt (after tax) = 11.5% *(1- tax)

= 11.5% * (1- 0.40)

= 6.9%

2) Current price = next year dividend / (required rate of return - growth rate)

$27 = $2 (1+0.08) /  (required rate of return - 0.08)

$27 = $2.16 /  (required rate of return - 0.08)

$27 * (required rate of return - 0.08) = $2.16

$27 *required rate of return - $2.16 = $2.16

$27 *required rate of return = $2.16 + 2.16

$27 *required rate of return = $4.32

required rate of return = $4.32 / $27

required rate of return = 16%

Therefore, cost of equity = 16%

3) WACC = Equity / [equity + debt] * cost of equity +  Debt / [equity + debt] * cost of debt (after tax)

= 0.6 / [0.4 + 0.6] * 16% + 0.4 / [0.4 + 0.6] * 6.9%

= 0.6 * 16% + 0.4 * 6.9%

= 9.6% + 2.76%

= 12.36%

4)    Cost of debt (after floatation cost) = Coupon + (face value - price )/ maturity /  {(face value + price )/ 2}

= ($1000 * 12%) + (1000 -1040(1-0.05))/20 /  {(1000 + 1040(1-0.05) )/ 2}

= ($1000 * 12%) + (1000 -988)/20 /  {(1000 + 988) / 2}

= 120 + 0.6 / 994

= 120.6 / 994

= 12.15%

cost of debt (after tax) = 12.15% * (1 - 0.4)

= 7.29%

Cost of equity (after floatation cost) = Next year dividend / current price * (1- floatation cost) + growth rate

= $2 (1+0.08) / $27(1-0.15) + 0.08

= $2.16 / $22.95 + 0.08

= 0.0941 + 0.08

= 17.41%

WACC = Equity / [equity + debt] * cost of equity +  Debt / [equity + debt] * cost of debt (after tax)

= 0.6 / [0.4 + 0.6] *17.41% + 0.4 / [0.4 + 0.6] * 7.29%

= 0.6 * 17.41%   + 0.4 * 7.29%

= 10.45%   + 2.92%

= 13.37%

5) Equity * (1 - floatation cost)= $10000000

Equity (1 - 0.15) = $10000000 * 60%

Equity = $6000000 / 0.85

Equity = 7058824

Debt (1 - floatation cost) = $10000000 *40%

  Debt (1 -0.05) = $4000000

Debt = $4000000 / 0.95

Debt = 4210526

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