Show me the steps to solve During the last few years, Danny$$s Fabulous Fried Chicken Competitor, Delta Cubed has been to

constrained by the high cost of capital to make many capital investments. Recently, though, capital

costs have been declining, and the company has decided to look seriously at a major expansion

program proposed by the marketing department. Assume that you are a consultant to Leigh Jones,

the financial vice president. Your first task is to estimate Delta$$s 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 $35\%.$

$$ The current price of Delta$$s $12\mathrm{.}5\%$ coupon, semiannual payment, noncallable bonds with

$15$ years remaining to maturity is $$.$ Delta$$s does not use short$-$term interest$-$bearing debt

on a permanent basis. New bonds would be privately placed with no flotation cost.

$$ The current price of the firm$$s $10\%,$ $$100$ par value, quarterly dividend, perpetual

preferred stock is $$.$ Delta$$s would incur flotation costs equal to $6\%$ of the proceeds on a

new issue.

$$ Delta$$s common stock is currently selling at $$70$ per share. Its last dividend $($D$0)$ was $$,$

and dividends are expected to grow at a constant rate of $5\mathrm{.}8\%$ in the foreseeable future.

Delta$$s beta is $1\mathrm{.}4,$ the yield on T$-$bonds is $5\mathrm{.}6\%,$ and the market risk premium is

estimated to be $6\%.$ For the own$-$bond$-$yield$-$plus$-$judgmental$-$ risk$-$premium approach,

the firm uses a $3\mathrm{.}2\%$ risk premium.

$$ Delta$$s target capital structure is $30\%$ long$-$term debt, $10\%$ preferred stock, and $60\%$

common equity.

Table:

Group $1$ Group $2$ Group $3$ Group $4$ Group $5$ Group $6$ Group $7$ Group $8$

Bond

price $1155\mathrm{.}701152\mathrm{.}551150\mathrm{.}251145\mathrm{.}771158\mathrm{.}361122\mathrm{.}651105\mathrm{.}671118\mathrm{.}26$

Preferred

Stock

price $116\mathrm{.}50110\mathrm{.}23107\mathrm{.}54109\mathrm{.}57118\mathrm{.}11113\mathrm{.}15114\mathrm{.}27108\mathrm{.}49$

D$02\mathrm{.}883\mathrm{.}023\mathrm{.}123\mathrm{.}313\mathrm{.}223\mathrm{.}403\mathrm{.}293\mathrm{.}35$

To help you structure the task, Leigh Jones has asked you to answer the following questions.

a$.$ What is the market interest rate on Delta$$s debt, and what is the component cost of this debt

for WACC purposes?

b$.$ What is the firm$$s cost of preferred stock?

c$.$ Delta doesn$$t plan to issue new shares of common stock. Using the CAPM approach, what is

Delta$$s estimated cost of equity?

d$.(1)$ What is the estimated cost of equity using the discounted cash flow $($DCF$)$ approach?

$(2)$ Suppose the firm has historically earned $15\%$ on equity $($ROE$)$ and has paid out $65\%$

of earnings, and suppose investors expect simi lar values to obtain in the future. How

could you use this information to estimate the future dividend growth rate, and what

growth rate would you get?

e$.$ What is the cost of equity based on the own$-$bond$-$ yield$-$plus$-$judgmental$-$risk$-$premium

method?

f$.$ What is your final estimate for the cost of equity, rs$?$

g$.$ What is Delta$$s weighted average cost of capital $($WACC$)?$

h$.$ Delta 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

debt is typically $12\%,$ and $(3)$ they have a beta of $1\mathrm{.}75.$ Given this information, what would your

estimate be for the new division$$s cost of capital?

i$.(1)$ Delta estimates that if it issues new common stock, the flotation cost will be $12\mathrm{.}5\%.$

Delta incorporates the flotation costs into the DCF approach. What is the estimated cost

of newly issued common stock, taking into account the flotation cost?

$(2)$ Suppose Delta issues $30-$year debt with a par value of $$1,000$ and a coupon rate of

$10\%,$ paid annually. If flotation costs are $3\%,$ what is the after$-$tax cost of debt for the

new bond issue?