Reference no: EM132975691

Question -

A. APT Ltd has debt with a market value of $350,000, preferred stock with a market value of $150,000, and common stock with a market value of $450,000. If debt has a cost of 8%, preferred stock a cost of 10%, common stock a cost of 12%, and the firm has a tax rate of 30%. Calculate the firm's weighted cost of capital (WACC).

B. You work for the firm and management is considering expanding into a completely new line of business. The financial manager has asked you to determine an appropriate WACC for an average-risk project in the expansion division. You find two publicly traded stand-alone firms that produce the same products in this new division. The average of the two firms' betas is 1.25. Further, you determine that the expected return on the market portfolio is 13% and the risk-free rate of return is 4.%. The firm finances 50% of its projects with equity and 50% with debt and has a before-tax cost of debt of 9% and a corporate tax rate of 30%.

Required -

i. Determine the firm's cost of equity using the SML approach.

ii. Determine the WACC for the new line of business?

C. Sometimes preferred stock is referred to as "hybrid equity financing." Identify and explain the features of preferred stock that give it the designation of "hybrid equity financing."

D. What are the advantages and disadvantages of using the DCF model for determining the cost equity capital.