Question
In Assignment 3, you were able to estimate the cost of capital for a company. This is essential for many financial roles including capital budgetingdeciding
In Assignment 3, you were able to estimate the cost of capital for a company. This is essential for many financial roles including capital budgetingdeciding which projects a company should take onand valuation. You might want to value a company for a private transaction, for your investment portfolio, or for fair value calculations. There are 100 marks available for this assignment. See the questions below for mark distribution. Make sure to clearly explain your work so that your Open Learning Faculty Member can give feedback. You may get partial marks, even if your final answer is incorrect. Respond to the following: 1. The Rollag Co. just issued a dividend of $2.75 per share on its common stock. The company is expected to maintain a constant 5.8% growth rate in its dividends indefinitely. If the stock sells for $59 a share, what is the company's cost of equity? (10 marks) 2. Suppose Whitney Ltd. just issued a dividend of $2.08 per share on its common stock. The company paid dividends of $1.71, $1.82, $1.93, and $1.99 per share in the last 4 years. The stock currently sells for $45. a. What is your best estimate of the company's cost of equity capital using the arithmetic average growth rate in dividends? (10 marks) b. What if you use the geometric average growth rate? (10 marks) c. What constraints are there in choosing a long-term dividend growth rate (e.g., minimums or maximums)? Explain your answer. (10 marks) 3. Peacock Corp. has a target capital structure of 70% common stock, 5% preferred stock, and 25% debt. Its cost of equity is 11%, the cost of preferred stock is 5%, and the cost of debt is 7%. The relevant tax rate is 35%. . What is Peacock's WACC? (10 marks) a. The company president has approached you about Peacock's capital structure and wants to know why the company does not use more preferred stock financing because it costs less than debt. What would you tell the president? (10 marks) 4. Holyrood Co. just paid a dividend of $2.45 per share. The company will increase its dividend by 20% next year and will then reduce its dividend growth rate by 5 percentage points per year until it reaches the industry average of 5% dividend growth (i.e., 20%, 15%, 10%, 5%), after which the company will keep a constant growth rate forever. If the required return on Holyrood stock is 11%, what will a share of stock sell for today? (15 marks) 5. Peachytown Bank just issued some new preferred stock. The issue will pay a $20 annual dividend in perpetuity, beginning 20 years from now. If the market requires a 5.8% return on this investment, how much does a share of preferred stock cost today? (15 marks) 6. What are the advantages of using the security market line (SML) approach to finding the cost of equity capital? What are the disadvantages? What are the specific pieces of information needed to use this method? Are all of these variables observable, or do they need to be estimated? What are some of the ways you could get these estimates? (10 marks)
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