Tutorial 2 Model Answer

Question 1:

r = ($5/$70) + 0.03 = 10.14%

Question 2:

a. N= 4 , Most Recent Dividend= $ 3.10, Oldest Dividend= $2.12

Growth Rate = ((3.10/2.12)^1/4) -1 =0.0997 or 9.97%

b. Cost of existing Common Stocks

c. Cost of New issue of Common Stocks

Question 2:The risk premium of the market is: Rm – Rf = 11% - 6% = 5%

Question 3:

After Tax Cost of Debt (ri) = 8.56% (1-40%) = 5.14%

c. g=10%*(1-40%)= 6%
 d.

E. Cost of Capital

Source of Capital Weights. Cost of Capital Weighted Cost

Source
Long Term Debt 75,053,000/375,265,000= 0.2 5.14% 1.028%

Preferred Stock 112,579,500/375,265,000=0.3 8.44% 2.532%

Common Stock 187,632,500/375,265,000=0.5 13.78% 6.89%

WACC= (1.028 + 2.532 +

6.89) = 10.45 %

F. Only Project B can be accepted because the expected return is higher than the WACC.