Start with the partial model in the file Ch09 P18 Build a Model.xlsx on the textbook’s Web site. The stock of Gao Computing sells for $50, and last year’s dividend was $2.10. A flotation cost of 10% would be required to issue new common stock. Gao’s preferred stock pays a dividend of $3.30 per share, and new preferred stock could be sold at a price to net the company $30 per share. Security analysts are projecting that the common dividend will grow at a rate of 7% a year. The firm can issue additional long-term debt at an interest rate (or a before-tax cost) of 10%, and its marginal tax rate is 35%. The market risk premium is 6%, the risk-free rate is 6.5%, and Gao’s beta is 0.83. In its cost-of-capital calculations, Gao uses a target capital structure with 45% debt, 5% preferred stock, and 50% common equity. A: Calculate the cost of each capital component—in other words, the after-tax cost of debt, the cost of preferred stock (including flotation costs), and the cost of equity (ignoring flotation costs). Use both the CAPM method and the dividend growth approach to find the cost of equity. B: Calculate the cost of new stock using the dividend growth approach.
Start with the partial model in the file Ch09 P18 Build a Model.xlsx on the textbook’s Web site. The stock of Gao Computing sells for $50, and last year’s dividend was $2.10. A flotation cost of 10% would be required to issue new common stock. Gao’s preferred stock pays a dividend of $3.30 per share, and new preferred stock could be sold at a price to net the company $30 per share. Security analysts are projecting that the common dividend will grow at a rate of 7% a year. The firm can issue additional long-term debt at an interest rate (or a before-tax cost) of 10%, and its marginal tax rate is 35%. The market risk premium is 6%, the risk-free rate is 6.5%, and Gao’s beta is 0.83. In its cost-of-capital calculations, Gao uses a target capital structure with 45% debt, 5% preferred stock, and 50% common equity. A: Calculate the cost of each capital component—in other words, the after-tax cost of debt, the cost of preferred stock (including flotation costs), and the cost of equity (ignoring flotation costs). Use both the CAPM method and the dividend growth approach to find the cost of equity. B: Calculate the cost of new stock using the dividend growth approach.
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
Related questions
Question
Start with the partial model in the file Ch09 P18 Build a Model.xlsx on the textbook’s Web site. The stock of Gao Computing sells for $50, and last year’s dividend was $2.10. A flotation cost of 10% would be required to issue new common stock. Gao’s
A: Calculate the cost of each capital component—in other words, the after-tax cost of debt, the cost of preferred stock (including flotation costs), and the
B: Calculate the cost of new stock using the dividend growth approach.
Transcribed Image Text:Solution
7/16/2015
Chapter:
Problem:
18
INPUTS USED IN THE MODEL
Po
$50.00
Net P.
$30.00
D
Do
$3.30
$2.10
7%
B-T ra
10%
Skye's beta
0.83
Market risk premium, RPM
6.0%
Risk free rate, ras
Target capital structure from debt
Target capital structure from preferred sti
Target capital structure from common sto
|Таx rate
Flotation cost for common
6.5%
45%
5%
50%
35%
10%
a. Calculate the cost of each capital component, that is, the after-tax cost of debt, the cost of
preferred stock (including flotation costs), and the cost of equity (ignoring flotation costs). Use both
the the CAPM method and the dividend growth approach to find the cost of equity.
Cost of debt:
B-T ra
(1- T)
A-T ra
Build a Model
Transcribed Image Text:Cost of preferred stock (including flotation costs):
Net Pe
Cost of common equity, dividend growth approach (ignoring flotation costs):
D,
Po
Cost of common equity, CAPM:
b x RPM
IMPORTANT NOTE: HERE THE CAPM AND THE DIVIDEND GROWTH METHODS PRODUCE APPROXIMATELY
THE SAME COST OF EQUITY. THAT OCCURRED BECAUSE WE USED A BETA IN THE PROBLEM THAT FORCED
THE SAME RESULT. ORDINARILY, THE TWO METHODS WILL PRODUCE SOMEWHAT DIFFERENT RESULTS.
b. Calculate the cost of new stock using the dividend growth approach.
Do x (1 + g) /
Po. (1 - F)
$2.25
$45.00
7%
11.99%
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
This is a popular solution!
Trending now
This is a popular solution!
Step by step
Solved in 3 steps with 2 images
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Recommended textbooks for you
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education