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Suppose that Company ABC will deliver a dividend of $2.5 per share next year. Its common stock is traded at $55 per share. Market investors
Suppose that Company ABC will deliver a dividend of $2.5 per
share next year. Its common stock is traded at $55 per share. Market investors
expect the company's sales will rise 8% a year. Suppose that stock floatation cost
is 15% of stock sales.
1.a (5 marks) What is the cost of equity if only retained earnings is used?
1.b (5 marks) What is the cost of equity if new equity is issued?
1.c (5 marks) What is the retained earnings breakpoint for ABC this year?
1.d (10 marks) If ABC has a target capital structure of 40% in common equity and
50% in debt, and the company is expected to have a net income of $200 million
this year. The company has maintained a payout rate of 50%. If ABC wants to
invest in a new project that requires a capital investment of $400 million, what is
the average WACC for this new project? Assume that ABC can borrow at a rate of
6%.
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