Fama's llamas has a weighted average

Finance

Suppose Stark Ltd. just issued a dividend of $1.92 per share on its common stock. The company paid dividends of $1.50, $1.65, $1.72, and $1.83 per share in the last four years.

If the stock currently sells for $40, what is your best estimate of the company’s cost of equity capital using the arithmetic average growth rate in dividends? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Cost of equity

%

What if you use the geometric average growth rate? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Cost of equity

%

Drogo, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 16 years to maturity that is quoted at 105 percent of face value. The issue makes semiannual payments and has an embedded cost of 10 percent annually.

What is the company’s pretax cost of debt? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Pretax cost of debt

%

If the tax rate is 35 percent, what is the aftertax cost of debt? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Aftertax cost of debt

%

Fama’s Llamas has a weighted average cost of capital of 9.3 percent. The company’s cost of equity is 13 percent, and its pretax cost of debt is 7.3 percent. The tax rate is 40 percent. What is the company’s target debt−equity ratio? (Do not round intermediate calculations and round your final answer to 4 decimal places, e.g., 32.1616.)

Debt−equity ratio

Dinklage Corp. has 6 million shares of common stock outstanding. The current share price is $89, and the book value per share is $8. The company also has two bond issues outstanding. The first bond issue has a face value of $85 million, a coupon of 6 percent, and sells for 96 percent of par. The second issue has a face value of $60 million, a coupon of 7 percent, and sells for 109 percent of par. The first issue matures in 21 years, the second in 9 years.

a.

What are the company's capital structure weights on a book value basis? (Do not round intermediate calculations and round your answers to 4 decimal places, e.g., 32.1616.)

Equity/Value

Debt/Value

b.

What are the company’s capital structure weights on a market value basis? (Do not round intermediate calculations and round your answers to 4 decimal places, e.g., 32.1616.)

Equity/Value

Debt/Value

c.

Which are more relevant, the book or market value weights?

Market value

Book value

An all-equity firm is considering the following projects:

Project

Beta

IRR

W

.54

10.1

%

X

.91

10.6

Y

1.09

14.1

Z

1.51

17.1

The T-bill rate is 5.1 percent, and the expected return on the market is 12.1 percent.

a.

Compared with the firm's 12.1 percent cost of capital, Project W has a expected return, Project X has a expected return, Project Y has a expected return, and Project Z has a expected return.

b.

Project W should be , Project X should be , Project Y should be , and Project Z should be .

c.

If the firm's overall cost of capital were used as a hurdle rate, Project W would be , Project X would be , Project Y would be , and Project Z would be .