P12-42. Estimating WACC and Expected Growth in Dividend Discount Model United Parcel Service Inc. was trading at $97.53 at December 31, 2018. Its dividend per share was $3.84, its market beta was estimated to be 1.44, its average pretax borrowing rate was 2.6%, and its assumed statutory tax rate was 22.4%, consisting of the 21% federal rate plus the 1.4% state and local rate, net of any federal benefits. UPS's market value of equity (market capitalization) was $83.90 billion, computed as 860.2386 million shares times its $97.53 price, and its total market value (enterprise value) was $107.19 billion, computed as $83.90 billion in equity plus the fair value of long-term debt of $23.29 billion (disclosed in note 8 of the financial statements). Assume a risk-free rate of 2.1% and a market risk premium of 5% to answer the following requirements. Required a. Estimate UPS's cost of debt capital, cost of equity capital, and weighted average cost of capital. b. Using the dividend discount model, and assuming a constant perpetuity at its current dividend level, estimate UPS's intrinsic value per share. c. Using the Gordon Growth DDM, and assuming next period's dividends equal $3.84 and grow at a constant rate for each period thereafter, infer the market's expected growth in dividends that are neces- sary for UPS's intrinsic value to equal its observed price per common share. Discuss the reasonable- ness of this growth factor. P12-42. Estimating WACC and Expected Growth in Dividend Discount Model United Parcel Service Inc. was trading at $97.53 at December 31, 2018. Its dividend per share was $3.84, its market beta was estimated to be 1.44, its average pretax borrowing rate was 2.6%, and its assumed statutory tax rate was 22.4%, consisting of the 21% federal rate plus the 1.4% state and local rate, net of any federal benefits. UPS's market value of equity (market capitalization) was $83.90 billion, computed as 860.2386 million shares times its $97.53 price, and its total market value (enterprise value) was $107.19 billion, computed as $83.90 billion in equity plus the fair value of long-term debt of $23.29 billion (disclosed in note 8 of the financial statements). Assume a risk-free rate of 2.1% and a market risk premium of 5% to answer the following requirements. Required a. Estimate UPS's cost of debt capital, cost of equity capital, and weighted average cost of capital. b. Using the dividend discount model, and assuming a constant perpetuity at its current dividend level, estimate UPS's intrinsic value per share. c. Using the Gordon Growth DDM, and assuming next period's dividends equal $3.84 and grow at a constant rate for each period thereafter, infer the market's expected growth in dividends that are neces- sary for UPS's intrinsic value to equal its observed price per common share. Discuss the reasonable- ness of this growth factor
