Financial Planning Problems

Multiple part:

(The following information applies to the next six problems.)

Rollins Corporation 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 sell for $1,000. The firm could sell, at par, $100 preferred stock which pays a 12 percent annual dividend, but flotation costs of 5 percent would be incurred. Rollins' beta is 1.2, the risk-free rate is 10 percent, and the market risk premium is 5 percent. Rollins is a constant-growth firm which just paid a dividend of $2.00, sells for $27.00 per share, and has a growth rate of 8 percent. The firm's policy is to use a risk premium of 4 percentage points when using the bond-yield-plus-risk-premium method to find r_s. The firm's marginal tax rate is 40 percent.

[i]. What is Rollins' component cost of debt?

a. 10.0%

b. 9.1%

c. 8.6%

d. 8.0%

e. 7.2%

[ii]. What is Rollins' cost of preferred stock?

a. 10.0%

b. 11.0%

c. 12.0%

d. 12.6%

e. 13.2%

[iii]. What is Rollins' cost of common stock (r_s) using the CAPM approach?

a. 13.6%

b. 14.1%

c. 16.0%

d. 16.6%

e. 16.9%

[iv]. What is the firm's cost of common stock (r_s) using the DCF approach?

a. 13.6%

b. 14.1%

c. 16.0%

d. 16.6%

e. 16.9%

[v]. What is Rollins' cost of common stock using the bond-yield-plus-risk-premium approach?

a. 13.6%

b. 14.1%

c. 16.0%

d. 16.6%

e. 16.9%

[vi]. What is Rollins' WACC?

a. 13.6%

b. 14.1%

c. 16.0%

d. 16.6%

e. 16.9%

(The following information applies to the next three problems.)

J. Ross and Sons Inc. has a target capital structure that calls for 40 percent debt, 10 percent preferred stock, and 50 percent common equity. The firm's current after?tax cost of debt is 6 percent, and it can sell as much debt as it wishes at this rate. The firm's preferred stock currently sells for $90 per share and pays a dividend of $10 per share; however, the firm will net only $80 per share from the sale of new preferred stock. Ross's common stock currently sells for $40 per share. The firm recently paid a dividend of $2 per share on its common stock, and investors expect the dividend to grow indefinitely at a constant rate of 10 percent per year.

[vii]. What is the firm's cost of common stock, r_s?

a. 10.0%

b. 12.5%

c. 15.5%

d. 16.5%

e. 18.0%

[viii]. What is the firm's cost of newly issued preferred stock, r_ps?

a. 10.0%

b. 12.5%

c. 15.5%

d. 16.5%

e. 18.0%

[ix]. What is the firm's weighted average cost of capital (WACC)?

a. 9.5%

b. 10.3%

c. 10.8%

d. 11.4%

e. 11.9%

Answer: a

[x]. Allison Engines Corporation has established a target capital structure of 40 percent debt and 60 percent common equity. The firm expects to earn $600 in after-tax income during the coming year, and it will retain 40 percent of those earnings. The current market price of the firm's stock is P₀ = $28; its last dividend was D₀ = $2.20, and its expected growth rate is 6 percent. Allison can issue new common stock at a 15 percent flotation cost. What will Allison's marginal cost of equity capital (not the WACC) be if it must fund a capital budget requiring $600 in total new capital?

a. 15.8%

b. 13.9%

c. 7.9%

d. 14.3%

e. 9.7%

[xi]. Hilliard Corp. wants to calculate its weighted average cost of capital (WACC). The company’s CFO has collected the following information:

· The company’s long-term bonds currently offer a yield to maturity of 8 percent.

· The company’s stock price is $32 per share (P₀ = $32).

· The company recently paid a dividend of $2 per share (D₀ = $2.00).

· The dividend is expected to grow at a constant rate of 6 percent a year (g = 6%).

· The company pays a 10 percent flotation cost whenever it issues new common stock (F = 10%).

· The company’s target capital structure is 75 percent equity and 25 percent debt.

· The company’s tax rate is 40 percent.

· The company anticipates issuing new common stock during the upcoming year.

What is the company’s WACC?

a. 10.67%

b. 11.22%

c. 11.47%

d. 12.02%

e. 12.56%

---

%.