Question:
Estimating WACC and Expected Growth in Dividends Model
Assume FedEx Corporation (NYSE: FDX) was trading at $107.47 at May 31, 2011. Its dividend per share was $0.36, its market beta was estimated to be 0.7, its average borrowing rate is 9.7%, and its marginal tax rate is 36%. FedEx's market value of equity (market cap) is $32.95 billion and its total market value (enterprise value) is $34.31 billion. Assume a risk-free rate of 4.0% and a market risk premium of 4.4% to answer the following requirements.
(a) Estimate FedEx's cost of debt capital, cost of equity capital, and weighted average cost of capital. (Round your answers to one decimal place.)
Cost of debt capital = ?
Cost of equity capital = ?
Calculate the weighted average cost of capital. (Use your rounded answers from above. Do not round until your final answer. Round to one decimal place.)
Weighted average cost of capital = ?
(b) Using the dividend discount model, and assuming a constant perpetuity for dividends, estimate FedEx's intrinsic value per share. (Use the rounded cost of equity capital calculated in (a). Round your answer to two decimal places.)
(c) Using the Gordon growth DDM and assuming next period's dividends equal $0.36 and grow at a constant rate for each period thereafter, infer the market's expected growth in dividends that are necessary for FedEx's intrinsic value to equal $107.47 per common share. Assume that its cost of equity capital is 7.1%. (Do not round until your final answer. Round to one decimal place.)
Discuss the reasonableness of this growth factor. (Choose One)
(a) The growth in dividend factor is close to what was expected due to the fact DDM places the correct amount of weight on the dividends beyond the forecast horizon.(b)The growth in dividend factor is lower than expected due to the fact DDM places a tiny amount of weight on the dividends beyond the forecast horizon.(c)The growth in dividend factor is higher than expected due to the fact DDM places a tremendous amount of weight on the dividends beyond the forecast horizon.