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Stock of Gao Computing sells for $50, and dividend of last year was $2.10. Flotation cost of 10% would be needed to issues new common stock.

Gao's favoured stock pays the dividend of $3.30 per share, and new favoured could be sold at the price to net company $30 per share.

Security analysts are projecting that common dividend will grow at the rate of 7% a year.

The company can also issue extra long-term debt at the interest rate (or before-tax cost) of 10%, and its marginal tax rate is 35%.

Market risk premium is= 6%, risk free rate is= 6.5%, and Gao's beta is= 0.83.

In its cost-of-capital computations, Gao uses the target capital structure with 45% debt, 5% favoured stock, and 50% common equity

i) Compute cost of each capital component, like, after-tax cost of debt, cost of preferred stock, cost of equity (ignoring flotation costs) with DCF method and CAPM method.

ii) Compute cost of new stock by using DCF model.

iii) Determine the cost of new common stock, based on CAPM? Determine the difference between ke and ks as determined by the DCF method, and add that differential to CAPM value for ks.

iv) By using target capital structure for Gao Computer and suppose that it will not issue new equity, will continue to use similar capital structure, determine the WACC?

Basic Finance, Finance

  • Category:- Basic Finance
  • Reference No.:- M914105

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