Question No 3 9 Marks

Answer the following.

1. The future earnings, dividends, and common stock price of Nabeel Inc. are expected to grow 7% per year. Common stock currently sells for $23.00 per share; its last dividend was $2.00.

a. Using the DCF approach, what is its cost of common equity?

b. If the firms beta is 1.6, the risk-free rate is 9%, and the average return on the market is 13%, what will be the firms cost of common equity using the CAPM approach?

c. If the firms bonds earn a return of 12%, based on the bond-yield-plus-risk-premium approach, what will be rs?

d. If you have equal confidence in the inputs used for the three approaches, what is your estimate of cost of common equity?

2. XYZ Industries plans to issue perpetual preferred stock with an $11.00 dividend. The stock is currently selling for $97.00; but flotation costs will be 5% of the market price per share. What is the cost of the preferred stock, including flotation?

3. Noman Electric Company (NEC) uses only debt and common equity. It can borrow unlimited amounts at an interest rate of rd = 10% as long as it finances at its target capital structure, which calls for 45% debt and 55% common equity. Its last dividend was $2, its expected constant growth rate is 4%, and its common stock sells for $20. NECs tax rate is 40%.

Two projects are available: Project A has a rate of return of 13%, while Project Bs return is 10%. These two projects are equally risky and about as risky as the firms existing assets.

a. What is its cost of common equity?

b. What is the WACC?

c. Which projects should Noman accept?