Cost of Capital

1 January 2017

The Wind Rider Company has just issued a dividend of $2. 10 per share on its common stock. The company is expected to maintain a constant 7% growth rate on its dividends indefinitely. If the stock sells for $40 a share, what is the company’s cost of equity? 2. ) The Ball Corporation’s common stock has a beta of 1. 15. If the risk free rate is 5% and the expected return on the market is 12%, what is Ball Corp. ’s cost of equity capital? 3. Stock in Parrothead Industries has a beta of 1. 10. The market risk premium is 8% and T-bills are currently yielding 5. 50%. Parrothead’s most recent dividend was $2. 20 per share and dividends are expected to grow at a 5% annual rate indefinitely. If the stock sells for $32 per share, what is the best estimate of Parrothead’s cost of equity? 4. ) Holdup Bank has an issue of preferred stock with a $5 stated dividend that just sold for $92 per share. What is the bank’s cost of preferred stock? 5. ) Legend, Inc. , is trying to determine its cost of debt.

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The firm has a debt issue outstanding with 12 years to maturity that is quoted at 107% of face value. The issue makes semiannual payments and has an embedded cost of 10% annually. What is Legend’s pretax cost of debt? If the tax rate is 35%, what is the after tax cost of debt? 6. ) Jiminy’s Cricket Farm issued a 30-year, 9% semi-annual bond 8 years ago. The bond currently sells for 105% of its face value. The company’s tax rate is 35%. a. ) What is the pretax cost of debt? b. ) What is the after tax cost of debt? 7. Mullineaux Corporation has a target capital structure of 50% common stock, 5% preferred stock, and 45% debt. Its cost of equity is 18%, the cost of preferred stock is 6. 50%, and the pre-tax cost of debt is 8%. The relevant tax rate is 35%. a. ) What is Mullineaux’s WACC? b. ) The company president has approached you about Mullineaux’s capital structure. He wants to know why the company doesn’t use more preferred stock financing since it costs less than debt. What would you tell the president? 8

Modigliani Manufacturing has a target debt-equity ratio of . 5. Its cost of equity is 18% and its pre-tax cost of debt is 10%. If the tax rate is 35%, what is Modigliani’s WACC? 9. ) Fama’s Llamas has a weighted average cost of capital of 12. 50%. The company’s cost of equity is 15% and its cost of debt is 8%. The tax rate is 35%. What is Fama’s target debt-equity ratio? 10. ) Sniffles, Inc. has a target debt-equity ratio of . 90. Its WACC is 13% and the tax rate is 35%. a. ) If Sniffles’ cost of equity is 18%, what is its pretax cost of debt? b. ) If instead you know that the after tax cost of debt is 7. 0%, what is the cost of equity? 11. ) Given the following information for Dunhill Power Co. , find the WACC. Assume the company’s tax rate is 35%. a. ) Debt: 3,000, 8% coupon bonds outstanding, $1000 par value, 20 years to maturity, selling for 103% of par. The bonds make semiannual payments. b. ) Common Stock: 90,000 shares outstanding, selling for $45 per share; the beta is 1. 20. c. ) Preferred stock: 13,000 shares of 7% preferred stock outstanding, currently selling for $108 per share. d. ) Market: 8% market risk premium and 6% risk-free rate

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