chapter 9

Here is the condensed 2021 balance sheet for Skye Computer Company (in thousands of dollars) Current assets Net fixed assets Total assets 2021 $1,600 2.400 $4,000 Accounts payable and accruals Short-term debt Long-term debt Preferred stock (10,000 shares) Common stock (40,000 shares) Retained earnings Total common equity Total abilities and equity $ 600 200 1,250 250 825 875 $1,700 $4,000 Skye's earnings per share last year were $2.60. The common stock sells for $45.00, last year's dividend (D) was $170, and a flotation cost of 12% would be required to sell new common stock. Security analysts are projecting that the common dividend will grow at an annual rate of 9% Skye's preferred stock pays a dividend of $2.70 per share, and its preferred stock sells for $30.00 per share. The firm's before-tax cost of debt is 11%, and its marginal tax rate is 25%. The firm's current outstanding 11% annual coupon rate, long-term debt sells at par value. The market risk premium is 6, the risk free rates 7%, and Skye's beta is 1.782. The firm's total debt, which is the sum of the company's short-term debt and long-term debt, equals $1.45 million The data has been collected in the Microsoft Excel file below. Open the spreadsheet and perform the required analysis to answer the questions below. Do not round Intermediate calculations. Round your answers to two decimal places Download spreadsheet Calculating the WACC-b62bdwlsx a. Calculate the cost of each capital component, that is, the after-tax cost of debt, the cost of preferred stock, the cost of equity from retained 1. Calculate the cost of each capital component, that is, the after tax cost of debt, the cost of preferred stock, the cost of equity from retained earings, and the cost of newly issued common stock. Use the DCF method to find the cost of common equity, After-tax cost of debt Cost of preferred stock! Cost of retained earnings Cost of new common stock b. Now calculate the cost of common equity from retained earnings, using the CAPM method. c. What is the cost of new common stock based on the CAPM? (Hint: Find the difference between t, and I, as determined by the DCF method, and ads that differential to the CAPM value for ro) d. 1 Skye continues to use the same market value capital structure, what is the firm's WACC assuming that (1) it uses only retained dating for equity and (2) if it expands so rapidly that it must issue new common stock? (Hint Use the market value capital structure excluding current Habilities to determine the weights. Also, use the simple average of the required values obtained under the two methods in calculating WACC) WACC: WACC) Calculating the WACC Skye Computer Company: Balance Sheet as of December 31 (in thousands of dollars) 2021 Current assets $1,600 Net fixed assets 2,400 Total assets $4,000 Accounts payable and accruals $600 Short-term debt 200 Long-term debt 1,250 3 Preferred stock 250 4 Common stock 825 5 Retained eamings 875 6 Total common equity $1,700 17 Total liabilities and equity $4,000 18 19 Last year's eamings per share + $2.60 20 Current price of common stock, Po $45.00 21 Last year's dividend on common stock, D. $1.70 22 Growth rate of common dividend, 9 9% 23 Flotation cost for common stock, F 12% 24 Common stock outstanding 40,000 25 Current price of preferred stock, P $30.00 26 Dividend on preferred stock, D, $2.70 27 Preferred stock outstanding 10,000 28 Before-tax cost of debt, 11% 29 Market risk premium, 6% 30 Risk-free rate, o 7% 31 Beta 1.782 32 Tax rate 25% 33 Total debt $1,450 thousand 34 35 a. Calculating the cost of each capital component (using the DCF method to find the cost of common equity) 37 After-tax cost of debt 36 Cost of proferred stock 30 Cout of retained eamings 40 Cout of now common stock 42. Calculating the cost of common equity from retained earnings, using the CAPM method 43 Cost of retained eaming 44 45. Calculating the cost of new common stock based on the CAPM 46 Potation cost adjustment LUCE Current assets Het fod assets Total assets D 51,00 2.400 $4.000 Accounts payable and soul Short-term debt ong-lom debt Preferred stock Common stock Retained comings Total convon eqully Totallaties and equity 3600 200 1,250 250 025 875 $1,700 14.000 $260 $45.00 5170 9% 12% + Last year's eamings per share Current price of common stock, P Last year's dividend on common stock Growth rate of common dividend, Flotation cost for common stock F Common stock outstanding Current price of preferred stock, P Dividend on preferred stock. O, Preferred stock outstanding Before-tax cost of debt. Mantrisk premium Risk free ruta, Beta Tax rate Total debt 40.000 $30.00 $2.70 10,000 11% 6% 736 1.782 25% $1.450 thousand Formulas Calculating the cost of each capital component using the DCF method to find the cost of common equity) After tax cost of debt Cost of prefard stock Cost of retained emings Cost of new common stock ANA ANA NA b. Calculating the cost of common equity from retained earnings using the CAP method 3 Cost of retained eaming NA NA WA c. Calculating the cost of new common stock based on the CAPM Flotation cost adjustment Cost of new common stock B 9 d. Calculaung the firm's WACC Assuming that it uses only retained earnings for equity and (2) if it expande e rapidly that it mustisse now common stock Market value Sheeft + Market value Ready E WIRD Ol preferred stock, Dividend on proferred stock D, Preferred stock outstanding Before-tax cost of debt, Markat risk premium - Risk-free rate. Beta Tax rate Total debt SUU $2.70 10,000 11% 8% 7% 1.782 25% $1,450 thousand Formulas a. Calculating the cost of each capital component using the DCF method to find the cost of common equity) After-tax cost of debt Cost of preferred stock Cost of retained oamings Cost of new common stock NA UNA SNA NA b. Calculating the cost of common equity from retained earnings, using this APM method Cost of retained oamings BUA NA WNA Weight We Market value in thousanda WNA ANA NA ENA 5 c. Calculating the cost of new common stock based on the CAPM 5 Flotation cost adjustment Cost of new common stock 3 9 d. Calculating the firm's WACC assuming that (1) it uses only retained earnings for equity and (2) If it expands so rapidly that it must issue new common stock Market value 1 in thousands) 2 Total debt -3 Preferred stock 4. Common equity 55 Total 56 S7 WACC 58 WACC 50 GD 61 52 53 64 65 66 57 60 09 NA NA Sheet1 +