marketing department. Assume that you are an assistant to Leigh Jones, the financial vice president. Your first task is to estimate Harry Davis' cost of capital. Jones has provided you with the following data, which she believes may be relevant to your task: The firm's tax rate is 35%. The current price of Harry Davis' 12.5% coupon, semiannual payment. noncallable bonds with 15 years remaining to maturity is S. Harry Davis does not use short-term interest- bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost. . Bond. price DO The current price of the firm's 10%, $100 par value, quarterly dividend, perpetual preferred stock is S. Harry Davis would incur flotation costs equal to 6% of the proceeds on a new issue. D Harry Davis' common stock is currently selling at $70 per share. Its last dividend (DO) was $, and dividends are expected to grow at a constant rate of 5.8% in the foreseeable future. Harry Davis' beta is 1.4. the yield on T-bonds is 5.6%, and the market risk premium is estimated to be 6%. For the own-bond-yield-plus-judgmental-risk-premium approach, the firm uses a 3.2% risk premium. Harry Davis' target capital structure is 30% long-term debt, 10% preferred stock, and 60% common equity. Group 1 1155.70 Preferred 116.50 Stock price 2.88 Group 2 1152.55 110.23 3.02 Group 3 1150.25 107.54 3.12 Group 4 Group 5 1145.77 1158.36 109.57 3.31 118.11 3.22 Group 6 Group 7 1122.65 113.15 3.40 1105.67 114.27 3.29 (3) Could the DCF method be applied if the growth rate were not constant? How? f. What is the cost of equity based on the own-bond- yield-plus-judgmental-risk-premium method? g. What is your final estimate for the cost of equity, rs? h. What is Harry Davis' weighted average cost of capital (WACC)? i. What factors influence a company's WACC? j. Should the company use its overall WACC as the hurdle rate for each of its divisions? k. What procedures can be used to estimate the risk-adjusted cost of capital for a particular di- vision? What approaches are used to measure a division's beta? 1. Harry Davis is interested in establishing a new division that will focus primarily on developing new Internet-based projects. In trying to determine the cost of capital for this new division, you discover that specialized firms involved in similar projects have, on average, the following characteristics: (1) their capital structure is 15% debt and 85% common equity. (2) their cost of marketing department. Assume that you are an assistant to Leigh Jones, the financial vice president. Your first task is to estimate Harry Davis' cost of capital. Jones has provided you with the following data, which she believes may be relevant to your task: The firm's tax rate is 35%. The current price of Harry Davis' 12.5% coupon, semiannual payment. noncallable bonds with 15 years remaining to maturity is S. Harry Davis does not use short-term interest- bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost. . Bond. price DO The current price of the firm's 10%, $100 par value, quarterly dividend, perpetual preferred stock is S. Harry Davis would incur flotation costs equal to 6% of the proceeds on a new issue. D Harry Davis' common stock is currently selling at $70 per share. Its last dividend (DO) was $, and dividends are expected to grow at a constant rate of 5.8% in the foreseeable future. Harry Davis' beta is 1.4. the yield on T-bonds is 5.6%, and the market risk premium is estimated to be 6%. For the own-bond-yield-plus-judgmental-risk-premium approach, the firm uses a 3.2% risk premium. Harry Davis' target capital structure is 30% long-term debt, 10% preferred stock, and 60% common equity. Group 1 1155.70 Preferred 116.50 Stock price 2.88 Group 2 1152.55 110.23 3.02 Group 3 1150.25 107.54 3.12 Group 4 Group 5 1145.77 1158.36 109.57 3.31 118.11 3.22 Group 6 Group 7 1122.65 113.15 3.40 1105.67 114.27 3.29 (3) Could the DCF method be applied if the growth rate were not constant? How? f. What is the cost of equity based on the own-bond- yield-plus-judgmental-risk-premium method? g. What is your final estimate for the cost of equity, rs? h. What is Harry Davis' weighted average cost of capital (WACC)? i. What factors influence a company's WACC? j. Should the company use its overall WACC as the hurdle rate for each of its divisions? k. What procedures can be used to estimate the risk-adjusted cost of capital for a particular di- vision? What approaches are used to measure a division's beta? 1. Harry Davis is interested in establishing a new division that will focus primarily on developing new Internet-based projects. In trying to determine the cost of capital for this new division, you discover that specialized firms involved in similar projects have, on average, the following characteristics: (1) their capital structure is 15% debt and 85% common equity. (2) their cost of
