# Homework: Cost Of Preferred Stock

7-2 Constant Growth Valuation Boehm Incorporated is expected to pay a $1. 50 per share dividend at the end of this year (i. e. , D1 = $1. 50). The dividend is expected to grow at a constant rate of 7% a year. The required rate of return on the stock, rs, is 15%. What is the value per share of Boehm’s stock? P = D1/(rs – g) Price = $1. 50 / (0. 15 – 0. 07) = $18. 75 7-4 Preferred Stock Valuation Nick’s Enchiladas Incorporated has preferred stock outstanding that pays a dividend of $5 at the end of each year. The preferred sells for $50 a share.

What is the stock’s required rate of return? Vps = Dps/Rps Vps = $5/$50 = 10% 7-5 Non-constant Growth Valuation 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, 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? Stock Return| 16. 50%| =0. 075+1. 2*(0. 115-0. 04)| Discounted| | | D1| 2. 0| =2*(1. 2)^1| 2. 06| =2. 40/(1+|0. 0165|)^1| D2| 2. 88| =2*(1. 2)^2| 2. 12| =2. 88/(1+|0. 0165|)^2| D3| 3. 08 | =2. 88*(1. 07) | | | | P2| 32. 44| =(3. 08)/(0. 0165-0. 07)| 23. 90| =32. 44/(1+|0. 0165|)^2| Stocks Current Price| | 28. 08| | | 9-2 After-Tax Cost of Debt LL Incorporated’s currently outstanding 11% coupon bonds have a yield to maturity of 8%. LL believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 35%, what is LL’s after-tax cost of debt? d(1 – T) = 0. 08(0. 65) = 5. 2%. 9-4 Cost of Preferred Stock with Flotation Costs 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? Ep = Dividend/ Market Price – Flotation Costs =($60*0. 06)/(($70-($70*0. 05))= 5. 41% 9-5 Cost of Equity – DCF Summerdahl Resort’s common stock is currently trading at $36 a share. The stock is expected to pay a dividend of $3. 0 a share at the end of the year (D1 = $3. 00), and the dividend is expected to grow at a constant rate of 5% a year. What is its cost of common equity? P0 = $36; D1 = $3. 00; g = 5%; rs= ? rs = D1/P0+ g = ($3. 00/$36. 00) + 0. 05 = 13. 33% 9-6 Cost of Equity – CAPM 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 last year was 15%. What is the estimated cost of common equity using the CAPM? s = rRF + bi(RPM) = 0. 06 + 0. 8(0. 055) = 10. 4% 9-7 WACC 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? rd = 6%; T = 40%; rps = 5. 8%; rs = 12%. WACC = (wd)(rd)(1 – T) + (wps)(rps) + (wce)(rs) WACC = 0. 30(0. 06)(1-0. 40) + 0. 05(0. 058) + 0. 65(0. 12) = 9. 17%