33. Determine the cost of capital, using the data box. a. What is the cost of de

Question

33. Determine the cost of capital, using the data box. a. What is the cost of debt? b. What is the firm's cost of preferred stock? c. What is the estimated cost of retained earnings using CAPM model? d. What is the estimated cost of retained earnings using DCF method? e. What is the estimated cost of retained earnings using bond-yield-plus-risk-premium approach? What is your final estimate for re? f. What is the cost of newly issued common stock, rElew? g. What is the overall, or weighted average cost of capital (WACC) when retained earnings are used as the equity component? h. What is the WACC after retained earnings have been exhausted and the company uses new common stock with 15 percent flotation costs?

Explanation / Answer

1) Cost of Debt = Coupon Rate * ( 1 - Tax Rate ) = 0.12 * ( 1 - 0.4 ) = 7.2%

2) Cost of Prefered Stock = Prefered Dividend / (Issue Price - Floatation Cost) = 10 / (113 - 2) = 9%

3) Estmiated Cost of Retained Earnings (As per CAPM) = Risk Free Rate + Beta * Market Risk Premium = 7% + 1.2 * 6% = 14.2%

4) Estmiated Cost of Retained Earnings (As per DCF) = { D1 / P0 } + G = {4.19 * ( 1 + 0.05 ) / 50 } + 0.05 = 13.79%

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