b. Now calculate the cost of common equity from retained earnings, using the CAPM method.%c. What is the cost of new common stock based on the CAPM? (Hint: Find the difference between r. and r, as determined by the DCF method, and add that differential to the CAPM value for r.)%d. If Skye continues to use the same market-value capital structure, what is the firm's WACC assuming that (1) it uses only retained earnings for equity and (2) if it expands so rapidly that it must issue new common stock?(Hint: Use the market value capital structure excluding current liabilities to determine the weights. Also, use the simple average of the required values obtained under the two methods in calculating WACC.)WACC;:%WACC2:% Here is the condensed 2021 balance sheet for Skye Computer Company (in thousands of dollars):2021Current assets$1,400Net fixed assets2,600Total assets$4,000Accounts payable and accruals$ 900Short-term debt200Long-term debt1,000Preferred stock (10,000 shares)250Common stock (40,000 shares)800Retained earnings850Total common equity$1,650Total liabilities and equity$4,000Skye's earnings per share last year were $2.90. The common stock sells for $45.00, last year's dividend (Do) was $2.00, and a flotation cost of 10% would be required to sell new common stock. Security analysts are projecting thatthe common dividend will grow at an annual rate of 10%. Skye's preferred stock pays a dividend of $3.00 per share, and its preferred stock sells for $30.00 per share. The firm's before-tax cost of debt is 12%, and its marginal taxrate is 25%. The firm's currently outstanding 12% annual coupon rate, long-term debt sells at par value. The market risk premium is 4%, the risk-free rate is 5%, and Skye's beta is 1.432. The firm's total debt, which is the sum ofthe company's short-term debt and long-term debt, equals $1.2 million.The data has been collected in the Microsoft Excel file below. Download the spreadsheet and perform the required analysis to answer the questions below. Do not round intermediate calculations. Round your answers to two decimalplaces.Download spreadsheet Calculating the WACC-dbfce7.xlsxa. Calculate the cost of each capital component, that is, the after-tax cost of debt, the cost of preferred stock, the cost of equity from retained earnings, and the cost of newly issued common stock. Use the DCF method to findthe cost of common equity.After-tax cost of debt:%Cost of preferred stock:%Cost of retained earnings:%Cost of new common stock:%

After tax cost of debt is the cost of debt after deducting the taxes. After-tax cost of debt = Before tax cost of debt * (1-tax rate)a] After tax cost of debt = Before tax cost of debt*(1-t) = 12%*(1-25%) = 9% Cost of preferred stock = Preferred dividends/Price = 3.0/30 = 10% Cost of retained earnings using DCF method = D0*(1+g)/P0+g where, D0 = Last dividend paid g = Growth rate in dividends P0 = Current price = (2.0*1.1/45)+0.10 = 14.89% Cost of new common stock using DCF method = D0*(1+g)/(P0-Flotation cost)+g = 2.0*1.1/(45-45*10%)+0.10 = 15.43%b) Cost of common equity from retained earnings using CAPM = Risk free rate +Beta*Market risk premium = 5%+(1.432*4%) = 10.73%c) Cost of new common stock using CAPM = 10.73%+(15.43%-14.89%) = 11.27%d) d] Simple average of cost of retained earnings = (14.89%+11.27%)/2 = 13.08% Simple average of new common equity = (15.43%+11.27%)/2 = 13.35% i] WACC using retained earnings: Component of capital structure Market Value Weight Component Cost WACC Debt [given] $ 1,200,000 36.36% 9.00% 3.27% Preferred stock [10000*30] $ 300,000 9.09% 10.00% 0.91% Common equity [Retained earnings] [40000*45] $ 1,800,000 54,55% 13.08% 7.14% Total $ 3,300,000 100.00% 11.32% WACC = 11.32% ii] WACC using new common equity: Component of capital structure Market Value Weight Component Cost WACC Debt [given] $ 1,200,000 36.36% 9.00% 3.27% Preferred stock [10000*30] $ 300,000 9.09% 10.00% 0.91% Common equity [Retained earnings] [40000*45] $ 1,800,000 54,55% 13.35% 7.28% Total $ 3,300,000 100.00% 11.46% WACC = 11.46%

Answered: b. Now calculate the cost of common…

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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With regard to the Earnings per Share (EPS), what kinds of actions can the firm take to increase the EPS?
To identify the cost of equity, which models are better: The dividend growth model or CAPM-derived cost of equity?
D O Assume that Kish Inc. hired you as a consultant to help estimate its cost of capital. You have obtained the following data: Do = $0.90; Po = $47-50; and g = 7.00% (constant). Based on the DCF approach, what is the cost of equity from retained earnings? Do not round your intermediate calculations. a. 2.03% b. 8.77% O c. 9.03% O d. 8.89% O e. 2.17% Q Search B G 8 40 E hp X Dropbox promotion fo 25 alt a W ctri *** prisc X delete backspace pause home
-n Weighted average cost of capital (WACC) is the: O A. O B. O C. O D. O E. Average IRR of the firm's current projects. Required rate of return on a firm. Cost of utilizing debt financing. Average rate of return needed to increase the value of a firm's stock. Cost of obtaining equity financing.
EXERCISE AIndicate whether each of the following statements is true or false. Support your answerswith the relevant explanations. 1. Under the conditions of perfect capital markets, the cost of capital of a companyfinanced fully by equity is expected to be equal to that of the same company butfinanced with 50% equity and 50% debt. (Explain your reasoning.)
To help them estimate the company's cost of capital, Smithco has hired you as a consultant. You have been provided with the following data: Do = $1.45; Po = $22.50; and g = 6.50% (constant). Based on the dividend growth approach, what is the cost of common from reinvested earnings? 11.68% 12,30% 12.56% 12.94% 13.36% O O o O o O
6. The Cost of Capital: Weighted Average Cost of Capital The firm's target capital structure is the mix of debr, preferred stock, and common equity the firm plans to raise funds for Its future projects. The target proportions of debt, preferred stock, and commonequity, along with the cost of these components, are used to calculate the firm's weighted average cost of capital (WACC). If the firm will not have to issue new common stock, then the cost of retained eamingsis used in the firm's WACC calcuation, However, If the fiem wil have to issue new common stock, the cost of new common stock should be used in the firm's WACC calculation. Quantitative Problem: Barton Industries expects that its tarpet capital structure for raising funds in the fubare for its capital budget wll consist of 40% debt, 5% preferred stock, and 55% common equity.Note that the firm's marginal tex rate is 25%. Assume that the firm's cost of debt, fe is 8.9%, the fem's cont of preferred stock, r is 8.1% and…
The cost of capital can be thought of as the rate of return required by investors in the firm's securities. O a. false O b. true
Apart from using PE ratio, what is another way of valuing the stock price? if we have the EPS, Share Price, Dividend Per Share, ROE and the discount rate (R). And what are the assumptions and the limitations of this model? What can be said about the dividend growth model? Similarly what can be said about the capital asset pricing model?
The cost of a firmʹs equity Group of answer choices a. is independent of the firmʹs capital structure b. will always be higher than the stated interest rate on the financial debt of the firm c. can be substantially higher than the firmʹs weighted average cost of capital d. must always be less than the firmʹs weighted average cost of capital
To eliminate all risk (including credit risk) an American company with a contract to sell goods to a foreign country can hedge by purchase a forward rate contract. O No answer text provided. O True O No answer text provided. O False
3. Consider the following two statements: Statement 1: A firm can either pay its earnings to its investors, or it can keep them and reinvest them; Statement 2: According to the constant dividend growth model, the share price of the firm depends on the current dividend level, divided by the cost of equity capital plus the grow rate. Which one of the following combinations (true/false) relating to the above statement is correct? A. Statement 1 Statement 2 True True B. Statement 1 Statement 2 True False C. Statement 1 Statement 2 False False D. Statement 1 Statement 2 False True

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