INSTRUCTIONS:
Answer the following questions, using spreadsheet financial functions to do the calculations.
Use the following information about SV Inc. to calculate the company’s Cost of Capital.
The stock of SV Inc. sells for $50, and last year’s dividend was $2.10.
A flotation cost of 10% would be required to issue new common stock.
SVs’ preferred stock pays a dividend of $3.30 per share, and new preferred could be sold at a price to net the company $30 per share.
Security analysts are projecting that the common dividend will grow at a rate of 7% a year.
The firm can issue additional long-term debt at an interest rate (or a before-tax cost) of 10%, and its marginal tax rate is 35%. The market risk premium is 6%, the risk-free rate is 6.5%, and Supreme Ventures’ beta is 0.83.
In its cost-of-capital calculations, SV Inc. uses a target capital structure with 45% debt, 5% preferred stock, and 50% common equity.
REQUIRED:
SECTION B
i. Calculate the cost of new stock using the DCF(DGM) model.
ii. What is the cost of new common stock based on the CAPM? (Hint: Find the difference between re and rs as determined by the DCF(DGM) method and then add that difference to the CAPM value for rs.)
iii. Assuming that SV will not issue new equity and will continue to use the same target capital structure, what is the company’s WACC?