Here is the condensed 2021 balance sheet for Skye Computer Company (in thousands of dollars):

	2021
Current assets		$	2,000
Net fixed assets			3,000
Total assets		$	5,000
Accounts payable and accruals		$	900
Short-term debt			200
Long-term debt			1,725
Preferred stock (15,000 shares)			475
Common stock (40,000 shares)			825
Retained earnings			875
Total common equity		$	1,700
Total liabilities and equity		$	5,000

Skye's earnings per share last year were $4.10. The common stock sells for $45.00, last year's dividend (D₀) was $3.30, and a flotation cost of 9% would be required to sell new common stock. Security analysts are projecting that the common dividend will grow at an annual rate of 8%. Skye's preferred stock pays a dividend of $4.20 per share, and its preferred stock sells for $35.00 per share. The firm's before-tax cost of debt is 12%, and its marginal tax rate is 25%. The firm's currently outstanding 12% 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 1.674. The firm's total debt, which is the sum of the company's short-term debt and long-term debt, equals $1.925 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.

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 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:

   Cost of preferred stock:

   Cost of retained earnings:

   Cost of new common stock:

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

3. 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.)

   

4. 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:

   WACC₂:

Here is the condensed 2021 balance sheet for Skye Computer Company thousands of dollars): Current assets Net fixed assets Total assets 2021 $2,000 3,000 $5,000 Accounts payable and accruals Short-term debt Long-term debt Preferred stock (15,000 shares) Common stock (40,000 shares) Retained earnings Total common equity Total liabilities and equity $ 900 200 1,725 475 825 875 $1,700 $5,000 Skye's earnings per share last year were $4.10. The common stock sells for $45.00, last year's dividend (Do) was $3.30, and a flotation cost of 9% would be required to sell new common stock. Security analysts are projecting that the common dividend will grow at an annual rate of 8%. Skye's preferred stock pays a dividend of $4.20 per share, and its preferred stock sells for $35.00 per share. The firm's before-tax cost of debt is 12%, and its marginal tax rate is 25%. The firm's currently outstanding 12% 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 1.674. The firm's total debt, which is the sum of the company's short-term debt and long-term debt, equals $1.925 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. 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 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: % 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 re and reas determined by the DCF method, and add that differential to the CAPM value for r.) % d. 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.) WACC: % WACC2: % D E F G H B C 4 (in thousands of dollars) 5 2021 6 Current assets $2,000 7 Net fixed assets 3,000 8 Total assets $5,000 9 10 Accounts payable and accruals $900 11 Short-term debt 200 12 Long-term debt 1,725 13 Preferred stock 475 14 Common stock 825 15 Retained earnings 875 16 Total common equity $1,700 17 Total liabilities and equity $5,000 18 19 Last year's earnings per share $4.10 20 Current price of common stock, Po $45.00 21 Last year's dividend on common stock, Do $3.30 22 Growth rate of common dividend, g 8% 23 Flotation cost for common stock, F 9% 24 Common stock outstanding 40,000 25 Current price of preferred stock, P $35.00 26 Dividend on preferred stock, Dp $4.20 27 Preferred stock outstanding 15,000 28 Before-tax cost of debt, la 12% 29 Market risk premium, - IRF 6% 30 Risk-free rate, IRF 7% 31 Beta 1.674 32 Tax rate 25% 33 Total debt $1,925 thousand 34 35 a. Calculating the cost of each capital component (using the DCF method to find 36 the cost of common equity) 37 After-tax cost of debt 38 Cost of preferred stock 39 Cost of retained earnings 40 Cost of new common stock 41 Formulas #N/A #N/A #N/A #N/A Total debt Formulas #N/A #N/A #N/A #N/A #N/A 34 35 a. Calculating the cost of each capital component (using the DCF method to find 36 the cost of common equity) 37 After-tax cost of debt 38 Cost of preferred stock 39 Cost of retained earnings 40 Cost of new common stock 41 42 b. Calculating the cost of common equity from retained earnings, using the CAPM method 43 Cost of retained earnings 44 45 c. Calculating the cost of new common stock based on the CAPM 46 Flotation cost adjustment 47 Cost of new common stock 48 49 d. Calculating the firm's WACC assuming that (1) it uses only retained earnings for equity and 50 (2) if it expands so rapidly that it must issue new common stock Market value (in thousands) Weight 52 Total debt 53 Preferred stock 54 Common equity 55 Total #N/A #N/A Weight #N/A Market value (in thousands) #N/A #N/A #N/A #N/A #N/A #N/A #N/A 3 3 g 57 WACC 58 WACC #N/A #N/A GA