4. DM Enterprises had earnings per share of $3.50 last year. Its common stock sells for $60. Last years dividend was $2.40 and a flotation cost of 10% would be required to sell new common stock. Security analysts are projecting that the common dividend will grow at an annual rate of 7%. DMs preferred stock pays a dividend of $2.50 per share and its preferred stock sells for $22 per share. The firm can issue long-term debt at an interest rate of 10%, and its marginal tax rate is 35%. The firms currently outstanding 10% annual coupon rate long-term debt sells at par value. The market risk premium is 10%, the risk-free rate is 3%, and DMs beta is 1.4 . The companys target capital structure is 25% debt, 5% preferred stock and 70% common equity.

a. Calculate the cost of each capital component, that is, the after-tax cost of debt, the cost of preferred stock and the cost of equity from retained earnings, and the cost of newly issued common stock. Use only the dividend yield plus growth approach to find the cost of equityfor both retained earnings and new shares.

b. Calculate the cost of retained earnings using CAPM.

c. What is the cost of new common stock using the CAPM?

d. Suppose DM Enterprises is equally confident in the estimates for the cost of equity obtained from CAPM and the dividend yield plus growth approach. What should be the cost of retained earnings? Of new shares?

e. If DM maintains the same capital structure, what is the firms wacc assuming it uses only retained earnings?

f. If DM maintains the same capital structure, what is the firms wacc assuming it expands so fast it must issue new shares?

5. Mirha Corps target capital structure consists of 40% debt and 60% common equity and its federal-plus-state tax rate is 40%. The firm must raise additional capital to fund its latest expansion. The company will have $3 million of retained earnings with a cost of 12%. New common stock in an amount of $9 million would have a cost of 15%. In addition, Mirha can raise up to $4 million of debt at an interest rate of 10% and an additional $5 million at a rate of 12%. Mirha Corps CFO expects that the proposed expansion will require an investment of $7.2 million. What is the wacc for this expansion project if Mirha expects to maintain its target capital structure?