Part I: Cost of Capital Analysis

Sarah Sharpe has given you the following information to help you estimate Wine Time (WT), Inc.'s weighted average cost of capital for 2020 (Dec).

(1) The bond quote on WT's long-term, semi-annual bond as reported in the financial press is as follows:

Bonds Annual Coupon Rate Maturity Date Price(% of par)

WT 5.2% Dec 2045 112.0

(2) Quotes on WT's common and preferred stock (pf) were as follows:

Stock Div. Div Yld% PE Vol(100s) Close Price Net Chg

WT 2.10 3.0 7.5 456 80 +1/4

WTpf 3.30 7.3 ---- 78 54. -1/8

(3) The 10-year Treasury bond rate is 1%. The companys investment bank recommends using this long-term treasury rate as the risk free rate for capital budgeting purposes.

(4) WT's federal-plus-state tax rate is 25 percent.

(5) The firm's last dividend (D0) was $2.10, and recent dividends have been growing at a rate of about 14%. Some analysts expect the recent growth rate to continue, while others expect it to go to zero as new competition enters the market, but the majority anticipate a growth rate of about 9% for the indefinite future. The company has 2 million shares outstanding.

(6) A prominent investment banking firm recently estimated that the market risk premium is 8 percent. WT's beta, as measured by several analysts who follow the stock, is 1.3.

(7) Any new preferred stock would be sold at the current Close Price of $54 per share and would incur flotation costs of $2.50 per share.

(8) The market value optimal target capital structure is based on the current market prices (from items (1) and (2)) times the following par value of bonds and shares of common and preferred stock respectively.

• Wine Time has bonds outstanding with a par value of $50 million

• Wine Time has 300,000 shares of preferred stock outstanding.

• Wine Time has 1.5 million shares of common stock outstanding.

  Sharpe then answered the following set of questions to complete her assigned task and has asked you to complete an independent verification of her results.

  Part I Questions:

1. What is your estimate of WT's after-tax cost of debt?

2. What is the estimate of the cost of preferred stock?

3. What is WT's estimated cost of retained earnings, using the CAPM approach?

4. What is the discounted cash flow (DCF) model estimate of WT's cost of retained

   earnings?

5. What is your choice of estimate for WTs cost of retained earnings?

6. What are WTs market value-based financing weights?

7. What is WTs weighted average cost of capital?