Reference no: EM131044928

Relion’s Weighted Average Cost of Capital Relion Inc. has appointed Amar Singh, CFA to help them in calculating the weighted average cost of capital for their firm. Given, below is the balance sheet information of Relion Inc. After discussing with company officials, board members and other constituencies, Singh realizes the firm’s capital structure is optimal. Partial Balance Sheet (in millions) Accounts Payable $20 Other current Liabilities 10 Long-term Debt 123 Preferred Stock 100 Common Stock 187 Total Liabilities & Stockholder’s Equity 440 Singh has obtained the following information through discussion with the firm’s investment bankers and financial officers: • Relion can sell 5-year callable bond with a 20-year maturity at a deep discount of $810.52 with quarterly coupon payments with a coupon rate of 12%. • The risk-free rate is 5 percent. • Relion stock has a systematic risk that is 30 percent greater than the market. The stock return is positively correlated with the market return. • The market risk-premium is 10 percent whereas the expected market return is 15 percent. • The firm currently pays $3 per share in dividends. Dividends have grown at 30% for next two years. Dividend growth will then stabilize to a growth rate of 5% forever. The analyst expect the firm’s common stock to sell at a price of $30 two years from today (P2= $30). • The firm is in the 40% marginal tax bracket. The executives of Relion Inc. has asked Singh to show all the steps used in the calculation. The executives understand that there is more than one way in calculating the required rate of return for common equity. They have requested Singh to use the two popular models and explain them the difference of the two models. Specifically, they are interested in knowing how each model incorporates risk. To reconcile the differences between the two models, they understand that Singh will use the average required rate of return for calculating the weighted average cost of capital. As part of Singh’s assignment, you are required to do the following: a. Calculate the yield on the callable bond assuming that it is called. b. Calculate the capital structure of Relion Inc. c. Calculate the after-tax cost of each component source of capital. For equity you are required to compute the cost using different models and take a consensus view of cost of equity. d. Explain the differences in the two models used for calculating the cost of common equity. e. Calculate the weighted average cost of capital