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Corporate Fiance Assignment Solution

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9 pages

Corporate Finance ADM 3350 M & P (Winter 2015) Assignment 1 Due Date: February 23, 2015 Question 1 (5 Marks) Varta Inc. has just issued a dividend of $1.50 per share on its common stock. The company paid dividends of $1.10, $1.15, $1.25, and $1.37 per share in the last four years. The stock currently sells for $48. a. What is your best estimate of the company's cost of equity capital using the arithmetic average growth rate in dividends? b. What if you use the geometric average growth rate? Solution: (3 + 2 = 5 Marks)

Part a. Period 1 2 3 4 5 dividend 1.1 1.15 1.25 1.37 1.5 Average growth (Arithmetic) growth 0.045 0.087 0.096 0.095 Growth = (P2 - P1)/P1

0.081

RE = D1/P0 + g = (D0 (1 + g))/P0 + g RE = 11.46%

Part b. We can get the
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Common 260,000 shares outstanding, selling for $58 per share; the beta is 1.15. stock: Preferred 18,000 shares of 6 percent preferred stock outstanding, currently selling for $95 stock: per share. Market: 7% percent market risk premium and 4.0 percent risk-free rate. 22. Note: You can use Excel’s ‘Rate’ function (as shown in the Cost of Capital Excel example) to find out YTM. Or, you can use a financial calculator, if you have one. As mentioned in the class, you will not be asked to find out YTM during the test, as you will not have an access to the computer at that time. Solution: (Market weights: 3 marks; Cost of various capital: 5 marks; WACC: 2 marks)

We will begin by finding the market value of each type of financing. We find: Price of each bond = Par value * market value as a percentage of par value = 1000*0.93 MVD = 9,000($1,000)(0.93) = $8,370,000 MVE = 260,000($58) = $15,080,000 MVP = 18,000($95) = $1,710,000 And the total market value of the firm is: V = $8,370,000 + 15,080,000 + 1,710,000 = $25,160,000 Now, we can find the cost of equity using the CAPM. The cost of equity is: RE = .04 + 1.15(.07) = .1205 or 12.05% The cost of debt is the YTM of the bonds, so:

Debt:

P0 = $930 = $32.50(PVIFAR%,40) + $1,000(PVIFR%,40) R = 3.58% YTM = 3.632% × 2 = 7.16% And the aftertax cost of debt is: RD = (1 – .40)(.0716) = .04298 or 4.298%

The cost of