Question

1) Lipscomb Corporation is estimating its WACC. Its target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sell for 1,000 USD. The firm could sell, at par, 100 USD preferred stock which pays a 12 percent annual dividend, but flotation costs of 5 percent would be incurred. Libscomb is a constant-growth firm which just paid a dividend of $2.00, sells for 27.00 USD per share, and has a growth rate of 8 percent. The firm's marginal tax rate is 40 percent.

2)

What is the value of Company X stock if the dividend next year will be $3 and is expected to grow at a rate of 4% forever if your required return is 10.74%?

Answer 1

1) Cost of debt is same as coupon rate as Bond is sold at par,
Cost of Debt=12%
Cost of Preferred Stock =Dividend/(Price*(1-Flotation Cost)) =12%*100/(100*(1-5%))=12.6316%
Cost of Equity =Dividend*(1+g)/Price + g=2*(1+8%)/27+8% =16%

WACC =Weight of equity*Cost of equity + Weight of Preferred Stock*Cost of Preferred Stock + Weight of Debt*Cost of Debt*(1-Tax Rate) =60%*16%+20%*12.6316%+20%*12%*(1-40%) =13.57%

2) Value of Company X =Dividend Next Year/(Required Rate-Growth) =3/(10.74%-4%) =44.51