Question
STR Ltd has 12,000 bonds outstanding, each with a face value of $100. The bonds pay an annual coupon of 12% and the most recent
STR Ltd has 12,000 bonds outstanding, each with a face value of $100. The bonds pay an annual coupon of 12% and the most recent coupon has just been paid. The bonds will mature in 6 years and currently have a yield to maturity of 15%. It has 100,000 preference shares outstanding which are currently trading at $8.75. The dividend rate on the preference shares is 14% and each share has a face value of $10. It also has 2 million ordinary shares outstanding which are currently trading at $3.06. STR has just paid a dividend of $0.50, and investors expect earnings and dividends to grow to a constant rate of 4 percent in the foreseeable future. There are no company taxes and management considers its present capital structure to be optimal and has no plans to change it.
a) Determine the cost of the various capital components and STRs before-tax weighted average cost of capital.
b) You show your calculations to a colleague, who argues that the dividend growth model is an unreliable way of estimating the cost of equity capital. She suggests you use the capital asset pricing model. You take her advice and you estimate STRs beta to be 1.8, the risk-free rate to be 5% and the expected market risk premium to be 8%. Calculate STRs new before-tax weighted average cost of capital.
c) Under what circumstances is it appropriate for STR to use the weighted average cost of capital estimated above as the discount rate to evaluate its projects? Explain.
I need step by step working outs along with explained formulas, thank you
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