Build a Model Solution 11/26/2018
Chapter: 9
Problem: 18
INPUTS USED IN THE MODEL
P0$50.00
D0$3.13
g7%
Flotation cost for common 10%
Ppf $32.61
Dpf $3.30
Flotation cost for preferred 8%
Beta 1.2
Market risk premium, RPM6.0%
Risk free rate, rRF 6.5%
Target capital structure from debt 45%
Target capital structure from preferred stock 5%
Target capital structure from common stock 50%
Cost of debt:
N = 40
PMT = $60.00
PV = -$1,171.59
FV = $1,000.00
Cost of preferred stock (including flotation costs):
Dpf / Net Ppf =rpf
$3.30 $30.00 =11.00%
Cost of common equity, dividend growth approach (ignoring flotation costs):
a. Calculate the cost of each capital component, that is, 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 the CAPM method and the dividend growth
approach to find the cost of equity.
Bond maturity 20
Payments per year 2
Bond price $1,171.59
Tax rate 25%
Cost of common equity, CAPM:
rRF + b × RPM =rs
6.5% 7.20% =13.700%
wd45.0%
wpf 5.0%
ws50.0%
c. Assuming that Gao will not issue new equity and will continue to use the same capital structure, what is the company’s
WACC?