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Build a Model: WACC Start with the partial model in the file Ch09 P18 Build a Model.xls on the textbook’s Web site. The stock of Gao Computing sells for $50, and last year’s dividend was

$2.10. A flotation cost of 10% would be required to issue new common stock.

Gao’s preferred stock pays a dividend of $3.30 per share, and new preferred could be sold at a price to net the company $30 per share. Security analysts are projecting that the common dividend will grow at a rate of 7% a year. The firm can issue additional long-term debt at an interest rate (or a before-tax cost) of 10%, and its marginal tax rate is 35%. The market risk premium is 6%, the risk-free rate is 6.5%, and Gao’s beta is 0.83. In its cost-of-capital calculations, Gao uses a target capital structure with 45% debt, 5% preferred stock, and 50% common equity.

a. Calculate the cost of each capital component—in other words, the after-tax cost of debt, the cost of preferred stock (including flotation costs), and the cost of equity

(ignoring flotation costs). Use both the DCF method and the CAPM method to find the cost of equity.