Intro

Greenberg Corp. is considering opening a subsidiary to expand its operations. To evaluate the proposal, the company needs to calculate its cost of capital. You've collected the following information:

• The firm has one bond outstanding with a coupon rate of 8%, paid semi-annually, 10 years to maturity and a current price of $1,071.06, implying a yield to maturity of 7%.
• The firm's preferred stock pays an annual dividend of $1.56 forever, and each share is currently worth $86.
• New bonds and preferred stock would be issued by private placement, largely eliminating flotation costs.
• Greenberg's beta is 0.7, the yield on Treasury bonds is is 2.6% and the expected market risk premium is 6%.
• The current stock price is $21.97. The firm has just paid an annual dividend of $0.64, which is expected to grow by 3% per year.
• The firm uses a risk premium of 4% for the bond-yield-plus-risk-premium approach.
• New equity would come from retained earnings, thus eliminating flotation costs.
• The firm has marginal tax rate of 34%.
• The company wants to maintain is current capital structure, which is 50% equity, 10% preferred stock and 40% debt.

Attempt 1/8 for 10 pts.

Part 1

What is the (pre-tax) cost of debt?

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Attempt 1/8 for 10 pts.

Part 2

What is the cost of preferred stock?

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Attempt 1/8 for 10 pts.

Part 3

What is the cost of equity using the CAPM?

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Attempt 1/8 for 10 pts.

Part 4

What is the cost of equity using the dividend growth model?

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Attempt 1/8 for 10 pts.

Part 5

What is the cost of equity using the bond yield plus risk premium?

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Attempt 1/8 for 10 pts.

Part 6

What is the company's weighted average cost of capital, using the CAPM to find the cost of equity?

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