PO $50.00 Net Ppt $30.00 Dpd $3.30 DO $2.10 9 TX B-Tid 10% Skye's beta ON Market risk premium RPM 6.0% Risk free rate RF 6.5% Target capital structure from debe 45% Target capital structure from prederred steck 5% Target capital structure from common stock 50% Tax rate 35% Flotation cost for common 10% a. Calculate the cost of each capital component that is, the after-tax cost of debt, the cost of preferred stock including Rotation costs, and the cost of equity ignoring flotation costs). Use both the the CAPM method and the dividend growth approach to find the cost of equity Cost of debt 9.Tid AT 2 points) Cost of preferred stock (including Rotation costs Dor Net Pol ror (2 points) Cost of common equity dividend growth approach ignoring flotation costs: D1 PO (2 points) Cost of common equity. CAPM: RPM 2 points) IMPORTANT NOTE: HERE THE CAPM AND THE DIVIDEND GROWTH METHODS PRODUCE APPROXIMATELY THE SAME COST OF EQUITY. THAT OCCURRED BECAUSE WE USED A BETA IN THE PROBLEM THAT FORCED THE SAME RESULT ORDINARILY, THE TWO METHODS WILL PRODUCE SOMEWHAT DIFFERENT RESULTS. b. Calculate the cost of new stock using the dividend growth approach. DO (1.9) PO (1-F) (2 points) c. What is the cost of new common stock based on the CAPM? (Hint Find the difference between re and is as determined by the dividend growth approach and add that differential to the CAPM value for rs.) Differential (2 points Again, we would not normally find that the CAPM and dividend growth methods yield identical results. d. Assuming that Gao will not issue new equity and will continue to use the same capital structure, what is the company's WACC) w 45.0% 5.0% ws 50.0% 100.0% wpl WAT rd - wppl WS WACC 12 points e. Suppose Gao is evaluating three projects with the following characteristics: (1) Each project has a cost of $1 million. They will all be financed using the target mix of long-term debt, preferred stock, and common equity. The cost of the common equity for each project should be based on the beta estimated for the project. All equity will come from reinvested earnings. 2) Equity invested in Project A would have a beta of 0.5. The project has an expected return of 9.0% a) Equity invested in Project I would have a beta of 1.0. The project has an expected return of 100%. 14) Equity invested in Project would have a beta of 2.0. The project has an expected return of 11.0% Analyze the company's situation and explain why each project should be accepted or rejected. Expected Beta ros rd(1-1) WACC retum on project Project A 05 Project Project Accuptor Reject 1 2 12 points) 12 points) 12 points)