## Question

A company currently pays a dividend of $2 per share (D0 = $2). It is estimated that the company’s dividend will grow at a rate of 20% per year for the next 2 years, and then at a constant rate of 7% thereafter. The company’s stock has a beta of 1.2, the risk-free rate is 7.5%, and the market risk premium is 4%. What is your estimate of the stock’s current price?

Investors require a 13% rate of return on Brooks Sister’s stock (rs = 13%).

a. What should the estimated value of Brook’s stock be if the previous dividend were D0 - $3.00 and if investors expect dividends to grow at a constant annual rate of (1) -5%, (2) 0%, (3) 5%, and (4) 10%?

b. Using data from part a., what is the constant growth model’s estimated value for Brook’s Sister’s stock if the required rate of return is 13% and the expected growth rate is (1) 13% or (2) 15%? Are these reasonable results? Explain.

c. Is it reasonable to expect that a constant growth stock would have g>rs?

Burnwood Tech plans to issue some $60 par preferred stock with a 6% dividend. A similar stock is selling on the market for $70. Burnwood must pay flotation costs of 5% of the issue price. What is the cost of the preferred stock?

Booher Book Stores has a beta of 0.8. The yield on a 3-month T-bill is 4%., and the yield on a 10-year T-bond is 6%. The market risk premium is 5.5%, and the return on an average stock in the market is last year was 15%. What is the estimated cost of common equity using the CAPM?

Shi Importer’s balance sheet shows $300 million in debt, $50 million in preferred stock, and $250 million in total common equity. Shi’s tax rate is 40%, rd = 6%, rps = 5.8%, and rs = 12%. If Shi has a target capital structure of 30% debt, 5% preferred stock, and 65% common stock, what is its WACC?

A company’s 6% coupon rate, semiannual payment, $1,000 par value bond that matures in 30 years sells at a price of $515.16. The company’s federal-plus-state tax rate is 40%. What is the firm’s after-tax component cost of debt for purposes of calculating the WACC? (Base the answer on the nominal rate.)

Spencer Supplies’ stock is currently selling for $60 a share. The firm is expected to earn $5.40 a share this year and to pay a year-end dividend of $3.60.

a. If investors require a 9% return, what rate of growth must be expected for Spencer?

b. If Spencer reinvests earnings in projects with average returns equal to the stock’s expected rate of return, then what will be next year’s EPS? (g = ROE x Retention ratio.)

Messman Manufacturing will issue common stock to the public for $30. The expected dividend and the growth in dividends are $3.00 per share and 5% respectively. If the flotation cost is 10% of the issue’s gross proceeds, what is the cost of external equity, re?

## Solution Preview

These solutions may offer step-by-step problem-solving explanations or good writing examples that include modern styles of formatting and construction of bibliographies out of text citations and references. Students may use these solutions for personal skill-building and practice. Unethical use is strictly forbidden.

By purchasing this solution you'll be able to access the following files:

Solution.xlsx.