Chapter 10

Topics: Corporate finance, Finance, Preferred stock Pages: 3 (489 words) Published: October 4, 2014
CHAPTER 10: COST OF CAPITAL

HOMEWORK

1. The Dempere Imports Company’s EPS in 2009 was $2.82, and in 2004 it was $1.65. The company’s payout ratio is 30%, and the stock is currently valued at $41.50. Flotation costs for new equity will be 15%. Net income in 2010 is expected to be $15 million. The market-value weights of the firm’s debt and equity are 40% and 60%, respectively.

a. Based on the five-year track record, what is Dempere’s EPS growth rate? What will the dividend be in 2010?

b. Calculate the firm’s cost of retained earnings and the cost of new common equity.

c. Calculate the break-point associated with retained earnings.

d. If Dempere’s after-tax cost of debt is 8%, what is the WACC only with debt and retained earnings? With debt and new common equity?

2. TRM Consulting Services currently has the following capital structure:

Source
Book Value
Quantity
Common Stock
$6,500,000
350,000
Preferred Stock
$375,000
7,500
Debt
$4,000,000
4,000

Debt is represented by 15-year original maturity bonds, issued five years ago, with a coupon rate of 8% and are currently selling for $965. The bonds pay interest semiannually. The preferred stock pays a $5 dividend annually and is currently valued at $60 per share. Flotation costs on debt and preferred equity are negligible and can be ignored, but they will be 8% of the selling price for common stock. The common stock, which can be bought for $32.00, has experienced a 5% annual growth rate in dividends and is expected to pay a $1.50 dividend next year. In addition, the firm expects to have $150,000 of retained earnings. Assume that TRM's marginal tax rate is 35%.

a. Set up a worksheet with all of the data from the problem in a well organized input area.

b. Calculate the book-value weights for each source of capital.

c. Calculate the market-value weights for each source of capital.

d. Calculate the component costs of capital (i.e., debt, preferred equity, retained...
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