Introduction

There are 100 marks available for this assignment.

For Assignment 4, you will demonstrate your comprehension of the concepts covered in Modules 6 and 7.

In your last assignment, you were able to estimate the cost of capital for a company. This is essential for many financial roles including capital budgeting—deciding which projects a company should take on—and valuation. You might want to value a company for a private transaction, for your investment portfolio, or for fair value calculations.

Make sure to clearly explain your work so that your Open Learning Faculty Member can give feedback. You may get partial marks, even if your final answer is incorrect. You will submit a single Word document for this assignment, please review the Submission Guidelines.

Instructions

Complete the following in the order listed, and label your work.

1. Rayburn Corporation has preferred stock that will pay an annual dividend of $3.76 every year in perpetuity. If the required return is 3.89%, what is the current stock price? (5 marks)
2. Roscoe Raspberry Corp. just paid an annual dividend of $2.53 on its common stock. They increase the dividend by 3.30% annually. What is the company’s cost of equity if the current stock price is $39.16 per share? (5 marks)
3. Wise Corporation stock has a beta of 1.21. The market risk premium is 7.20% and the risk-free rate is 2.94% annually. What is the company’s cost of equity? (5 marks)
4. What are the advantages of using the security market line (SML) approach to finding the cost of equity capital? What are the disadvantages? What are the specific pieces of information needed to use this method? Are all of these variables observable, or do they need to be estimated? What are some of the ways you could get these estimates? (5 marks)
5. Smart Corporation has a bond outstanding with a coupon rate of 6.1% and semi-annual payments. The bond has a $2,000 face value, a current price of $1,933 and matures in 19 years. The tax rate is 21%. What is the company’s after-tax cost of debt? (10 marks)
6. Sage Corp. has a cost of equity of 10.7%. The YTM on the company’s bonds is 5.3%, and the tax rate is 21%. The company’s bonds sell for 92.7% of par. The debt has a book value of $381,000, and total assets have a book value of $943,000. If the market-to-book ratio is 2.47 times, what is the company’s WACC? (10 marks)
7. Prudent Corp. has 16,100 shares of common stock outstanding at a price per share of $81 and a rate of return of 11.85%. The company also has 340 bonds outstanding, with a par value of $2,000 per bond. The pre-tax cost of debt is 6.25%, the bonds sell for 99% of par, and the tax rate is 21%. What is the company’s WACC? (10 marks)
8. Guru Corp. will pay the following dividends over the next 4 years: $12, $8, $7, and $2.50. After this time, the company will maintain a 5% growth rate in dividends. What is the current share price if the required return is 12%? (15 marks)
9. Shrewd Corp. just paid a $1.25 per share dividend. Dividends will grow at a rate of 28% for the next 8 years and then grow at a rate of 6% in perpetuity. What is the current share price if the required return is 13%? (15 marks)
10. Sharp Corp. has 10,000 bonds outstanding. These bonds are 6.4% coupon rate, $1,000 face value, and 25 years to maturity with semi-annual payments. They currently sell at 108, which means each $1,000 face value bond sells for $1,080. The company has 495,000 common shares selling at $63. They also have 35,000 of $3.50 preferred shares selling for $72 per share. The risk premium is 7%, and the risk-free rate is 3.2%. Beta is 1.15, and the tax rate is 35%. What is the company’s WACC? (20 marks)