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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Question
Rollins corporation has a target capital structure consisting of 20 percent debt, 20 percent preferred stock , and 60 percent common equity. Assume the firm has insufficient retained earnings to fund the equity portion of its capital budget. Its bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sells $1,200. The firm could sell, at par, $100 preferred stock that pays a 12 percent annual dividend, but flotation costs of 5 percent would be incurred. Rollins’ beta is 1.8, the risk-free rate is 10 percent, and the market return of 15 percent. Rollins is a constant growth firm that just paid a dividend of $2.00, sells for $27.00 per share, and has growth rate of 8 percent. The firms policy is to use a risk premium of 4 percentage points when using the bond-yield-plus-risk-premium method to find ks. Flotation costs on new common stock total 10 percent, and the firms marginal tax rate is 40 percent. What is rollins cost of retained earnings using the DCF approach?
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