School

University of Texas, Arlington **We aren't endorsed by this school

Course

FINA 3313

Subject

Finance

Date

Oct 16, 2023

Pages

4

Uploaded by hymmnal on coursehero.com

8.1.1 The Cost of Equity Financing
A stock plans a dividend of $8.00 per period, has a growth rate of 2% and a price of $50.00.
What is the cost of equity?
A firm has a beta of 1.3, the expected return on the market is 12%, and the risk-free rate is 5%.
What is the cost of equity?
Mavs Inc. wishes to determine its cost of common stock equity,
rs
. The market price,
P
0, of its
common stock is $35.86 per share. The firm expects to pay a dividend,
D
1, of $4.20 at the end of
the coming year, 2021. The dividends paid on the outstanding stock over the past 6 years (2015-
2020) were as follows:
The cost of equity is computed as shown below:
= (D1 / current price) + growth rate
growth rate is computed as follows:
= (Dividend in year 2020 / Dividend in year 2015)
1 / n
- 1
= ($ 4.10 / $ 3.60)
1 / 5
- 1
= 0.026351854
So, the cost of equity will be as follows:
= ($ 4.20 / $ 35.86) + 0.026351854
= 14.35% Approximately

Spanolia LLC is estimating its WACC. Its bonds have a 12 percent coupon, paid semiannually, a
current maturity of 20 years, and sell for 1,000 USD. The firm's marginal tax rate is 40 percent.
What is the after-tax cost of debt? Answer in % terms to 2 decimal places w/o the % sign.
Using Texas Instrument BA 2 plus calculator
SET N =
40,
PV =
-1000,
FV =
1000,
PMT
= 60
CPT --> I/Y =
6.00%
YTM =
2 * I/Y
YTM =
2 * 6.00%
YTM =
12.00%
Before tax cost of debt
= 12.00%
After tax cost of debt
=
Before tax cost of debt * (1 - Tax rate)
After tax cost of debt
= 12.00% * (1 - 40%)
After tax cost of debt
= 7.20%
LUVFINANCE, Inc. is estimating its WACC. The firm could sell, at par, $100 preferred stock
that pays a 10 percent annual dividend and incurs 4.32% flotation costs. What is the cost of new
preferred stock financing? Answer in % format to 2 decimal places w/o % sign.
The cost of preferred stock is computed as shown below:
= Annual dividend / [ Price x (1 - flotation cost) ]
=
100 x 10% = 10
= $ 10 / [ $ 100 x (1 - 0.0432) ]
= $ 10 / $ 95.68
= 10.45% Approximately
Compute the weight of common equity that should be used in the firm's WACC calculation if the
market value of the firm's debt is $59 million, the market value of the firm's preferred stock is $7
million and the market value of the firm's common equity is $111 million. Enter your answer as a
decimal (i.e. 0.54)
Weight of common equity:
=
Common Equity/(Debt+Preferred Stock+Common Equity)
= 111/(59+7+111)
= 0.63

Preston Corp. is estimating its WACC. Its target capital structure is 20 percent debt, 20 percent
preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon, paid
semiannually, a current maturity of 20 years, and sells for $1,100. The firm could sell, at par,
$100 preferred stock which pays a 5.42 percent annual dividend, but flotation costs of 5 percent
would be incurred. Preston's beta is 1.2, the risk-free rate is 3 percent, and the market risk
premium is 5 percent. The firm's marginal tax rate is 40 percent. What is Preston's WACC?
Cost of Equity:
= risk free rate+beta*market risk premium
=3%+1.2*5%
=9%
cost of preferred stock
= annual dividend/(price-floation cost)
=(5.42%)/(100-5%)
= 5.42/(100-5)
= .0571 = 5.71%
cost of debt
N =
20 *2 = 40
PV =
-1100
FV =
1000
PMT =
1000 * 12% = 120/2 = 60.00
CPT I/Y =
5.3861 *2 = 10.7722%
cost of debt after tax=10.77%*(1-40%)
=
.107722 * (1- .4)
= .0646 = 6.46 %
What is Preston's WACC
=Weight of equity*cost of equity+weight of preferred stock*cost of preferred stock+weight of
debt*cost of debt*(1-tax rate)
=60%*9%+20%*5.71%+20%*6.46%
= .6 * .09 + .2 * .0571 + .2 * .0646
=1.39% (answer)

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