Question

Rollins Corporation is estimating its WACC.  Its only bond issue has a 6.07 percent annual yield to...

Rollins Corporation is estimating its WACC.  Its only bond issue has a 6.07 percent annual yield to maturity, par value of $1,000, mature in 20 years, and has a 5.2% coupon paid semiannually (2.6%).  There is $100 million total par value of debt outstanding.  The firm currently has a $100 par preferred stock that pays a 7.5 percent annual dividend and currently yields 6 percent.  Flotation costs of 5 percent must be incurred on any new issue of preferred.  Current outstanding preferred stock has a total book value of $8 million.  Rollins' beta is 1.25, the risk-free rate is 4.5 percent, and the market risk premium is 6 percent. Rollins is a constant-growth firm that just paid a dividend of $0.47 last year.  Its common stock sells for $10.00 per share, has a dividend growth rate of 7 percent, and there are 10 million shares outstanding.  The CFO estimates that internally generated cash will be sufficient to supply additional equity funding.  The firm's policy is to use a risk premium of 6 percentage points when using the bond-yield-plus-risk-premium method to find rs.  The firm's marginal tax rate is 40 percent.  Please show all work and place answers in the space provided.  If you get stuck on an answer, assume a number, tell me, and continue onward to receive credit on other answers.

  1. What is Rollins' cost of debt?____________
  1. What is Rollins' cost of preferred stock?________
  1. What is Rollins' cost of common stock (rs) using the CAPM approach?_______

  1. What is the firm's cost of common stock (rs) using the DCF approach?_______
  1. What is Rollins' cost of common stock using the bond-yield-plus-risk-premium approach?_______
  1. Given your answers to the three previous questions, provide and explain your estimate of the cost of equity?________
  1. What are the appropriate weights for debt, preferred stock, and common stock?

            Debt weight                           _______

            Preferred stock weight         _______

            Common equity weight        _______

  1. What is Rollins' WACC?_______

Homework Answers

Answer #1

The yield of debt  is 6.07% and the rate of interest  is 5.2 %

That means debt is issued at discount of 14.33% ( 1 - (.052 / .0607)

Cost of Debt = [Interest Rate * ( 1 - tax Rate)] / (1-0.1433

Cost of Debt = [.052 * ( 1 - 0.40)] / 0.8567 = 3.64%

.

The yield of preference stock is 6% and the rate of dividend is 7.5%

That means the preference stock are issued at premium of 25% (.075 / .06 - 1)

Cost of Preferred Stock = Dividend % / Issue Price * (1 - Cost of Issue)

Cost of Preferred Stock = 0.075 / 1.25 ( 1-0.05) = 0.06315 or 6.315%

Cost of Common Stock = Rf + Beta * (Market Risk Premium)

Cost of Common Stock = 0.045 + ( 1.25 * .06)

Cost of Common Stock = 12%

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