Current assets		$	2,000
Net fixed assets			3,000
Total assets		$	5,000
Accounts payable and accruals		$	600
Short-term debt			200
Long-term debt			1,475
Preferred stock (15,000 shares)			325
Common stock (40,000 shares)			1,175
Retained earnings			1,225
Total common equity		$	2,400
Total liabilities and equity		$	5,000

Skye's earnings per share last year were $2.65. The common stock sells for $65.00, last year's dividend (D₀) was $1.75, 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 9%. Skye's preferred stock pays a dividend of $2.75 per share, and its preferred stock sells for $25.00 per share. The firm's before-tax cost of debt is 9%, and its marginal tax rate is 25%. The firm's currently outstanding 9% annual coupon rate, long-term debt sells at par value. The market risk premium is 6%, the risk-free rate is 7%, and Skye's beta is 1.536. The firm's total debt, which is the sum of the company's short-term debt and long-term debt, equals $1.675 million.

The data has been collected in the Microsoft Excel file below. Download 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-9a094a.xlsx

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 earnings, and the cost of newly issued common stock. Use the DCF method to find the cost of common equity.

After-tax cost of debt: 6.75 %

Cost of preferred stock: 11 %

Cost of retained earnings: 11.93%

Cost of new common stock: 12.26 %

Now calculate the cost of common equity from retained earnings, using the CAPM method.

16.22%

What is the cost of new common stock based on the CAPM? (Hint: Find the difference between r_e and r_s as determined by the DCF method, and add that differential to the CAPM value for r_s.)

16.55%

If Skye continues to use the same market-value capital structure, what is 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? (Hint: Use the market value capital structure excluding current liabilities to determine the weights. Also, use the simple average of the required values obtained under the two methods in calculating WACC.)

WACC₁: fill in the blank 8 %

WACC₂: fill in the blank 9 %