Reference no: EM133047094
Question - After reviewing the data in the problem, respond to the problems below. Indicate the answer you believe is correct.
LuckyStar Corporation has a target capital structure consisting of 20% debt, 20% preferred stock, and 60% common equity. Assume the firm has insufficient retained earnings to fund the equity portion of its capital budget. It has 20-year, 12% semiannual coupon bonds that sell at their par value of $1,000. The firm could sell, at par, $100 preferred stock that pays a 12% annual dividend, but flotation costs of 5% would be incurred. LuckyStar's beta is 1.2, the risk-free rate is 10%, and the market risk premium is 5%. LuckyStar is a constant growth firm that just paid a dividend of $2.00, sells for $27.00 per share, and has a growth rate of 8%. The firm's policy is to use a risk premium of 4% when using the bond-yield-plus-risk-premium method to find rs. Flotation costs on new common stock total 10%, and the firm's marginal tax rate is 40%.
Cost of debt
1. What is LuckyStar's component cost of debt?
a. 10.0%
b. 9.1%
c. 8.6%
d. 8.0%
e. 7.2%
2. What is LuckyStar's cost of preferred stock?
a. 10.0%
b. 11.0%
c. 12.0%
d. 12.6%
e. 13.2%
3. What is LuckyStar's cost of retained earnings using the CAPM approach?
a. 13.6%
b. 14.1%
c. 16.0%
d. 16.6%
e. 16.9%
4. What is the firm's cost of retained earnings using the DCF approach?
a. 13.6%
b. 14.1%
c. 16.0%
5. What is LuckyStar's cost of retained earnings using the bond-yield-plus-risk-premium approach?
a. 13.6%
b. 14.1%
c. 16.0%
d. 16.6%
e. 16.9%
6. What is LuckyStar's WACC, if the firm has insufficient retained earnings to fund the equity portion of its capital budget?
a. 13.6%
b. 14.1%
c. 16.0%
d. 16.6%
e. 16.9%
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