Start with the partial model in the file Ch11 P18 Build a Model.xlsx. The stock of Gao Computing sells for $70, and last year's dividend was $4.38. Security analysts are projecting that the common dividend will grow at a rate of 7% a year. A flotation cost of 11% would be required to issue new common stock. Gao's preferred stock sells for $21.74, pays a dividend of $2.20 per share, and new preferred stock could be sold with a flotation cost of 8%. The firm has outstanding bonds with 20 years to maturity, a 9% annual coupon rate, semiannual payments, and $1,000 par value. The bonds are trading at $839.54. The tax rate is 25%. The market risk premium is 6%, the risk-free rate is 6.5%, and Gao's beta is 1.2. In its cost-of-capital calculations, Gao uses a target capital structure with 40% debt, 10% preferred stock, and 50% common equity. The data has been collected in the Microsoft Excel file below. Download the spreadsheet and perform the required analysis to answer the questions below. Do not round intermediate calculations. Round your answers to two decimal places. Download spreadsheet Ch11 P18 Build a Model-e3a293.xlsx Calculate the cost of each capital component—in other words, the after-tax cost of debt, the cost of preferred stock (including flotation costs), and the cost of equity (ignoring flotation costs). Use both the CAPM method and the dividend growth approach to find the cost of equity. After-tax cost of debt 8.07% Wrong Cost of preferred stock (including flotation costs) 11.00% Correct Cost of common equity, dividend growth approach 13.70% Correct (ignoring flotation costs) Cost of common equity, CAPM 13.70% Correct Calculate the cost of new stock using the dividend growth approach. 14.52% Correct Assuming that Gao will not issue new equity and will continue to use the same target capital structure, what is the company's WACC? 11.17% Wrong

Managerial Accounting

15th Edition

ISBN:9781337912020

Author:Carl Warren, Ph.d. Cma William B. Tayler

Publisher:Carl Warren, Ph.d. Cma William B. Tayler

Chapter16: Financial Statement Analysis

Section: Chapter Questions

Problem 2MAD

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Start with the partial model in the file Ch11 P18 Build a Model.xlsx. The stock of Gao Computing sells for $70, and last year's dividend was $4.38. Security analysts are projecting that the common dividend will grow at a rate of 7% a year. A flotation cost of 11% would be required to issue new common stock. Gao's preferred stock sells for $21.74, pays a dividend of $2.20 per share, and new preferred stock could be sold with a flotation cost of 8%. The firm has outstanding bonds with 20 years to maturity, a 9% annual coupon rate, semiannual payments, and $1,000 par value. The bonds are trading at $839.54. The tax rate is 25%. The market risk premium is 6%, the risk-free rate is 6.5%, and Gao's beta is 1.2. In its cost-of-capital calculations, Gao uses a target capital structure with 40% debt, 10% preferred stock, and 50% common equity.

The data has been collected in the Microsoft Excel file below. Download the spreadsheet and perform the required analysis to answer the questions below. Do not round intermediate calculations. Round your answers to two decimal places.

Download spreadsheet Ch11 P18 Build a Model-e3a293.xlsx

Calculate the cost of each capital component—in other words, the after-tax cost of debt, the cost of preferred stock (including flotation costs), and the cost of equity (ignoring flotation costs). Use both the CAPM method and the dividend growth approach to find the cost of equity.

After-tax cost of debt	8.07% Wrong
Cost of preferred stock (including flotation costs)	11.00% Correct
Cost of common equity, dividend growth approach	13.70% Correct
(ignoring flotation costs)
Cost of common equity, CAPM	13.70% Correct

Calculate the cost of new stock using the dividend growth approach.

14.52% Correct
Assuming that Gao will not issue new equity and will continue to use the same target capital structure, what is the company's WACC?

11.17% Wrong

WACC
Current price of common stock, Po
Last year's dividend on common stock, Do
Growth rate of common dividend, g
Flotation cost for common stock
Current price of preferred stock, Pps
Preferred dividend, Dps
Flotation cost for preferred stock
Bond's years to maturity
Number of coupon payment per year
Annual coupon rate
Par value
Bond price
Tax rate
Market risk premium, RPM
Risk-free rate, TRF
Beta
Weight of long-term debt, wa
Weight of preferred stock, Wps
Weight of common stock, Ws
a. Calculating the cost of each capital component
Annual before-tax cost of debt
After-tax cost of debt
$70.00
$4.38
7%
11%
$21.74
$2.20
8%
20
2
9%
$1,000.00
$839.54
Cost of preferred stock (including flotation costs)
Cost of common equity, dividend growth approach (ignoring flotation costs)
Cost of common equity, CAPM
b. Calculating the cost of new stock using the dividend growth approach
Cost of new stock, dividend growth approach
25%
6.0%
6.5%
1.2
40%
10%
50%
Formulas
L#N/A
#N/A
#N/A
#N/A
#N/A
#N/A
c. Calculating the company's WACC if Gao will not issue new equity and will continue to use the same target capital structure
WACC
#N/A

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