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The following table gives the current balance sheet for Traveler Inn Inc. (TII), a company that was formed by merging a number of regional motel

The following table gives the current balance sheet for Traveler Inn Inc. (TII), a company that was formed by merging a number of regional motel chains.

Traveler Inn (Millions of Dollars)

Cash $10 Account payable $10

Account Receivable $20 Accrual $15

Inventory $20 Short-Term Debt $0

Current Assets $50 Current Liabilities $25

Net Fixed assets $50 Long Term debt $30

Preferred Stock (50,000 Shares) 5

Common equity

Common stock (3,300,000 shares) $10

Retained earnings 30

Total common equity $40

Total Assets $100 Total liabilities equity $100

The following facts also apply to TII.

  1. The long- term debt consists of 29,412 bonds, each having a 20- year maturity, semi- annual payments, a coupon rate of 7.6%, and a face value of $1,000. Currently, these bonds provide investors with a yield to maturity of 11.8%. if new bonds were sold, they would have an 11.8% yield to maturity.
  2. TLLs perpetual stock has a $100 per value, pays a quarterly dividend per shares of $2, and has a yield to investors of 10%. New perpetual preferred stock would have to provide the same yield to investors, and the company would incur a 3.85% flotation cost to sell it.
  3. The company has 3.8 million shares of common stock outstanding, a price per share = Po= $20, dividend per share= Do= $1, and earning per share = EPSo = $5. The return on equity (ROE) is expected to be 10%.
  4. The stock has a beta pf 1.6%. The T-bond rate is 6%, and RPm is estimated to be 5%.
  5. TIIs financial vice president recently polled some pension fund investment managers who hold TLLs securities regarding that minimum rate of return on TIIs common would make them willing to buy the common rather than TLL bonds, given that the bonds yielded 11.8%. the responses suggested a risk premium over TLL bonds of 3% point.
  6. TII is in the 25% federal -plus state tax bracket.

Assume that you were recently hired by TLL as a financial analyst and that your boss, the treasurer, has asked you to estimate the companys WACC under the assumption that no new equity will be issued. You cost of capital should be appropriate for use in evaluating projects that are in the same risk class as the assets TI now operate. Based on your analysis, answer the following questions.

  1. What are the current market value weights for debt, preferred stock, and common stock? (Hint: Do your work in dollars, not in millions of dollars. When you calculate the market values of debt and preferred stock, be sure to round the market price per bond and the market price per share of preferred to the nearest penny)
  2. What Is the after-tax cost of debt?
  3. What is the cost of preferred stock?
  4. What is the required return on common stock using CAPM?
  5. Use the retention growth equation to estimate the expected growth rate, then use the expected growth rate and the dividend growth model to estimate the required return on common stock.
  6. What is the required return on common stock using the own-bond-yield-plus judgement-risk-premium approach?
  7. Use the required return on stock from the CAPM model, and calculate the WACC.

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