Start with the partial model in the file Ch11 P18 Build a Model.xlsx. The stock of Gao Computing sells for $70, and last year's dividend was $4.38. Security analysts are projecting that the common dividend will grow at a rate of 7% a year. A flotation cost of 11% would be required to issue new common stock. Gao's preferred stock sells for $21.74, pays a dividend of $2.20 per share, and new preferred stock could be sold with a flotation cost of 8%. The firm has outstanding bonds with 20 years to maturity, a 9% annual coupon rate, semiannual payments, and $1,000 par value. The bonds are trading at $839.54. The tax rate is 25%. The market risk premium is 6%, the risk-free rate is 6.5%, and Gao's beta is 1.2. In its cost-of-capital calculations, Gao uses a target capital structure with 40% debt, 10% preferred stock, and 50% common equity. 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 decimal places. Download spreadsheet Ch11 P18 Build a Model-e3a293.xlsx 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. After-tax cost of debt 8.07% Wrong Cost of preferred stock (including flotation costs) 11.00% Correct Cost of common equity, dividend growth approach 13.70% Correct (ignoring flotation costs) Cost of common equity, CAPM 13.70% Correct Calculate the cost of new stock using the dividend growth approach. 14.52% Correct Assuming that Gao will not issue new equity and will continue to use the same target capital structure, what is the company's WACC? 11.17% Wrong

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
icon
Related questions
Question

Start with the partial model in the file Ch11 P18 Build a Model.xlsx. The stock of Gao Computing sells for $70, and last year's dividend was $4.38. Security analysts are projecting that the common dividend will grow at a rate of 7% a year. A flotation cost of 11% would be required to issue new common stock. Gao's preferred stock sells for $21.74, pays a dividend of $2.20 per share, and new preferred stock could be sold with a flotation cost of 8%. The firm has outstanding bonds with 20 years to maturity, a 9% annual coupon rate, semiannual payments, and $1,000 par value. The bonds are trading at $839.54. The tax rate is 25%. The market risk premium is 6%, the risk-free rate is 6.5%, and Gao's beta is 1.2. In its cost-of-capital calculations, Gao uses a target capital structure with 40% debt, 10% preferred stock, and 50% common equity.

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 decimal places.

 

 
Download spreadsheet Ch11 P18 Build a Model-e3a293.xlsx

 

  1. 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.

     

    After-tax cost of debt 8.07% Wrong
    Cost of preferred stock (including flotation costs) 11.00% Correct
    Cost of common equity, dividend growth approach 13.70% Correct 
    (ignoring flotation costs)
    Cost of common equity, CAPM 13.70% Correct

     

  2. Calculate the cost of new stock using the dividend growth approach.

    14.52% Correct

  3. Assuming that Gao will not issue new equity and will continue to use the same target capital structure, what is the company's WACC?

    11.17% Wrong

 

WACC
Current price of common stock, Po
Last year's dividend on common stock, Do
Growth rate of common dividend, g
Flotation cost for common stock
Current price of preferred stock, Pps
Preferred dividend, Dps
Flotation cost for preferred stock
Bond's years to maturity
Number of coupon payment per year
Annual coupon rate
Par value
Bond price
Tax rate
Market risk premium, RPM
Risk-free rate, TRF
Beta
Weight of long-term debt, wa
Weight of preferred stock, Wps
Weight of common stock, Ws
a. Calculating the cost of each capital component
Annual before-tax cost of debt
After-tax cost of debt
$70.00
$4.38
7%
11%
$21.74
$2.20
8%
20
2
9%
$1,000.00
$839.54
Cost of preferred stock (including flotation costs)
Cost of common equity, dividend growth approach (ignoring flotation costs)
Cost of common equity, CAPM
b. Calculating the cost of new stock using the dividend growth approach
Cost of new stock, dividend growth approach
25%
6.0%
6.5%
1.2
40%
10%
50%
Formulas
L#N/A
#N/A
#N/A
#N/A
#N/A
#N/A
c. Calculating the company's WACC if Gao will not issue new equity and will continue to use the same target capital structure
WACC
#N/A
Transcribed Image Text:WACC Current price of common stock, Po Last year's dividend on common stock, Do Growth rate of common dividend, g Flotation cost for common stock Current price of preferred stock, Pps Preferred dividend, Dps Flotation cost for preferred stock Bond's years to maturity Number of coupon payment per year Annual coupon rate Par value Bond price Tax rate Market risk premium, RPM Risk-free rate, TRF Beta Weight of long-term debt, wa Weight of preferred stock, Wps Weight of common stock, Ws a. Calculating the cost of each capital component Annual before-tax cost of debt After-tax cost of debt $70.00 $4.38 7% 11% $21.74 $2.20 8% 20 2 9% $1,000.00 $839.54 Cost of preferred stock (including flotation costs) Cost of common equity, dividend growth approach (ignoring flotation costs) Cost of common equity, CAPM b. Calculating the cost of new stock using the dividend growth approach Cost of new stock, dividend growth approach 25% 6.0% 6.5% 1.2 40% 10% 50% Formulas L#N/A #N/A #N/A #N/A #N/A #N/A c. Calculating the company's WACC if Gao will not issue new equity and will continue to use the same target capital structure WACC #N/A
Expert Solution
trending now

Trending now

This is a popular solution!

steps

Step by step

Solved in 3 steps with 3 images

Blurred answer
Knowledge Booster
Stock Market Analysis
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.
Similar questions
  • SEE MORE QUESTIONS
Recommended textbooks for you
Essentials Of Investments
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
FUNDAMENTALS OF CORPORATE FINANCE
FUNDAMENTALS OF CORPORATE FINANCE
Finance
ISBN:
9781260013962
Author:
BREALEY
Publisher:
RENT MCG
Financial Management: Theory & Practice
Financial Management: Theory & Practice
Finance
ISBN:
9781337909730
Author:
Brigham
Publisher:
Cengage
Foundations Of Finance
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
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…
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