Skye’s earnings per share last year were $3.20, the common stock sells for $55.00, last year’s dividend was $2.10, and a flotation cost of 10% would be required to sell new common stock. Security analysts are projecting that the common dividend will grow at a rate of 9% per year. Skye’s preferred stock pays a dividend of $3.30 per share, and new preferred could be sold at a price to net the company $30.00 per share. The firm can issue long-term debt at an interest rate (or before-tax cost) of 10%, and its marginal tax rate is 35%. The market risk premium is 5%, the risk-free rate is 6%, and Skye’s beta is 1.516. In its cost of capital calculations, the company considers only long-term capital; hence, it disregards current liabilities. Calculate the cost of each capital component, that is, the after-tax cost of debt, the cost of preferred stock, the cost of equity from retained earnings, and the cost of newly issued common stock. Use the DCF method to find the cost of common equity. Now calculate the cost of common equity from retained earnings using the CAPM method. What is the cost of new common stock based on the CAPM?
Dividend Valuation
Dividend refers to a reward or cash that a company gives to its shareholders out of the profits. Dividends can be issued in various forms such as cash payment, stocks, or in any other form as per the company norms. It is usually a part of the profit that the company shares with its shareholders.
Dividend Discount Model
Dividend payments are generally paid to investors or shareholders of a company when the company earns profit for the year, thus representing growth. The dividend discount model is an important method used to forecast the price of a company’s stock. It is based on the computation methodology that the present value of all its future dividends is equivalent to the value of the company.
Capital Gains Yield
It may be referred to as the earnings generated on an investment over a particular period of time. It is generally expressed as a percentage and includes some dividends or interest earned by holding a particular security. Cases, where it is higher normally, indicate the higher income and lower risk. It is mostly computed on an annual basis and is different from the total return on investment. In case it becomes too high, indicates that either the stock prices are going down or the company is paying higher dividends.
Stock Valuation
In simple words, stock valuation is a tool to calculate the current price, or value, of a company. It is used to not only calculate the value of the company but help an investor decide if they want to buy, sell or hold a company's stocks.
Skye’s earnings per share last year were $3.20, the common stock sells for $55.00, last year’s dividend was $2.10, and a flotation cost of 10% would be required to sell new common stock. Security analysts are projecting that the common dividend will grow at a rate of 9% per year. Skye’s
- Calculate the cost of each capital component, that is, the after-tax cost of debt, the cost of preferred stock, the
cost of equity fromretained earnings , and the cost of newly issued common stock. Use the DCF method to find the cost of common equity.
- Now calculate the cost of common equity from retained earnings using the
CAPM method. - What is the cost of new common stock based on the CAPM?
- If Skye continues to use the same capital structure, what is the firm’s WACC assuming that (1) it uses only retained earnings for equity? (2) If it expands so rapidly that it must issue new common stock?
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