Question

The Evanec Company's next expected dividend, D₁, is $3.90; its growth rate is 7%; and its common stock now sells for $33.00. New stock (external equity) can be sold to net $26.40 per share.

1. What is Evanec's cost of retained earnings, r_s? Do not round intermediate calculations. Round your answer to two decimal places.

   r_s =   %

2. What is Evanec's percentage flotation cost, F? Round your answer to two decimal places.

   F =   %

3. What is Evanec's cost of new common stock, r_e? Do not round intermediate calculations. Round your answer to two decimal places.

   r_e =   %

Evanec Company's has a target capital structure of 40% debt and 60% common equity, with no preferred stock. Its before-tax cost of debt is 10%, and its marginal tax rate is 25%. The current stock price is P₀ = $33.00. The last dividend was D₀ = $2.00, and it is expected to grow at a 5% constant rate. What is its cost of common equity and its WACC? Do not round intermediate calculations. Round your answers to two decimal places.

r_s =   %

WACC =   %

Answer 1

a.Stock price = Expected Dividend/(Cost of retained earnings – growth rate)

33 = 3.90/(Cost of Retained earnings – 7%)

Cost of Retained Earnings = 18.82%

b.% Flotation cost = (Selling price – Net proceeds)/Selling price

= (33-26.40)/33

= 20%

c.Stock Price – flotation cost = D1/(Cost of new equity – growth rate)

26.40 = 3.90/(Cost of new equity – 7%)

Cost of new equity = 21.77%

33 = 2(1+5%)/(Cost of Equity – 5%)

Cost of Equity = 11.36%

WACC = Cost of Debt*Weight of Debt + Cost of Equity*Weight of Equity

= 10%(1-25%)*40% + 11.36%*60%

= 9.816%

i.e. 9.82%