hocolate Comp $1.80, and company's payout ratio is 60%, and the stock is currently valued at $37.75. Flota- tion costs for new equity will be 12%. Net income in 2021 is expected to be $20 million. The company's investment banker estimates that it could sell 15-year semiannual bonds with a coupon rate of 6.5%. The face value would be $1,000 and the flota- tion costs for a bond issue would be 1%. The market-value weights of the firm's debt and equity are 30% and 70%, respectively. The firm faces a 25% tax rate. a. Based on the five-ycar track record, what is Chen's EPS growth rate? What will the dividend be in 2021? b. Calculate the firm's cost of retained earnings and the cost of new common equity. c. Calculate the break-point associated with retained earnings.
hocolate Comp $1.80, and company's payout ratio is 60%, and the stock is currently valued at $37.75. Flota- tion costs for new equity will be 12%. Net income in 2021 is expected to be $20 million. The company's investment banker estimates that it could sell 15-year semiannual bonds with a coupon rate of 6.5%. The face value would be $1,000 and the flota- tion costs for a bond issue would be 1%. The market-value weights of the firm's debt and equity are 30% and 70%, respectively. The firm faces a 25% tax rate. a. Based on the five-ycar track record, what is Chen's EPS growth rate? What will the dividend be in 2021? b. Calculate the firm's cost of retained earnings and the cost of new common equity. c. Calculate the break-point associated with retained earnings.
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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Concept explainers
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Question
Transcribed Image Text:A.
Chen Chocolate Company
2
EPS 2015
$
1.25
EPS 2020
Payout Ratio
$
1.80
4
60%
Stock Price
$
37.75
Flotation Costs (Equity)
12%
Net Income2021
$ 20,000,000
7
8
9.
Bond Face Value
$
1,000
10 Bond Coupon Rate
11 Bond Term to Maturity
12 Bond Payment Frequency
13 Flotation Costs (Bonds)
6.5%
15
1%
14 Tax Rate
25%
15
16 Capital Structure
17
Debt
30%
Equity
19 Pre-tax Cost of Debt
18
70%
20 After-tax Cost of Debt
21
22 EPS Growth Rate
23 Dividend2021
24 Cost of RE
25 Cost of New Equity
26 Retained Eanings2021
27
28
29 WACC
With Retained Earnings
With New Equity
30
31
%24
Transcribed Image Text:Chen Chocolate Company's EPS in 2020 was $1.80, and in 2015 it was $1.25. The
company's payout ratio is 60%, and the stock is currently valued at $37.75. Flota-
tion costs for new equity will be 12%. Net income in 2021 is expected to be $20
million.
The company's investment banker estimates that it could sell 15-year semiannual
bonds with a coupon rate of 6.5%. The face value would be $1,000 and the flota-
tion costs for a bond issue would be 1%. The market-value weights of the firm's
debt and equity are 30% and 70%, respectively. The firm faces a 25% tax rate.
a. Based on the five-year track record, what is Chen's EPS growth rate? What will
the dividend be in 2021?
b. Calculate the firm's cost of retained earnings and the cost of new common
equity.
c. Calculate the break-point associated with retained earnings.
d. What is the firm's after-tax cost of new debt?
What is the firm's WACC with retained carnings? With new common equity?
f.
Create a scatter chart that shows the firm's marginal WACC as a step func-
tion. The x-axis should go to at least $20 million. Be sure to fully label the
chart, including a data label with leader lines that shows the value of the
break-point.
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