Problem 9

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Chapter9-BuildaModel.xlsx

Build a Model

INPUTS USED IN THE MODEL
P0 $65.00
D0 $2.53
g 9%
Flotation cost for common 12%
Ppf $42.00
Dpf $3.32
Flotation cost for preferred 10%
Bond maturity 25
Payments per year 2
Annual coupon rate 15%
Par $1,000.00
Bond price $1,271.59
Tax rate 20%
Beta 1.2
Market risk premium, RPM 5.5%
Risk free rate, rRF 7.0%
Target capital structure from debt 40%
Target capital structure from preferred stock 10%
Target capital structure from common stock 50%
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:
N = 50
PMT = $75.00
PV = -$1,271.59
FV = $1,000.00
Semiannual yield = RATE =
Annual B-T rd =
B-T rd × (1 – T) = A-T rd
0% =
Cost of preferred stock (including flotation costs):
Dpf / Net Ppf = rpf
=
Cost of common equity, dividend growth approach (ignoring flotation costs):
D1 / P0 + g = rs
Cost of common equity, CAPM:
rRF + b × RPM = rs
=
b. Calculate the cost of new stock using the dividend growth approach (include flotation costs).
D0 × (1 + g) / P0 × (1 – F) + g = re

DII Labs: F is flotation cost.
c. Assuming that Gao will not issue new equity and will continue to use the same capital structure, what is the company's WACC?
wd 40.0%
wpf 10.0%
ws 50.0%
100.0%
wd × A-T rd + wpf × rpf + ws × rs = WACC
=