Reference no: EM132807050
During the last few years, C2 Industries has been too constrained by the high cost of capital to make many capital investments. Recently, though, capital costs have been declining, and the company has decided to look seriously at a major expansion program that has been proposed by the marketing department. Assume that you are an assistant to Ebenezer Scrooge, the financial vice-president. Your first task is to estimate C2's cost of capital. Scrooge has provided you with the following data, which he believes may be relevant to your task:
1. The firm's tax rate is 25%.
2. The current price of C2's 14% coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity is $1,252.36. There are 70,000 bonds. Jana does not use short-term interest-bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost.
3. The current price of the firm's 11%, $100 par value, quarterly dividend, perpetual preferred stock is $121.03. There are 200,000 outstanding shares. C2 would incur flotation costs equal to 5% of the proceeds on a new issue.
4. C2's common stock is currently selling at $49.86 per share. There are 3 million outstanding common shares. Its last dividend (D0) was $2.12, and dividends are expected to grow at a constant rate of 6.1 % in the foreseeable future. C2's beta is 1.3; the yield on T-bonds is 6.2%; and the market risk premium is estimated to be 5%. For the over-own-bond-yield-plus-judgmental-risk-premium approach, the firm uses a 3.2% judgmental risk premium.
5. C2's target capital structure is 30% long-term debt, 10% preferred stock, and 60% common equity.
Question 1 - What is the market interest rate on C2's debt, and what is the component cost of this debt for WACC purposes?
Question 2 - What is the firm's cost of preferred stock?
Question 3 - What is the cost of equity based on the bond-yield-plus-judgmental-risk-premium method?
Question 4 - Use C2's target weights to calculate the weighted average cost of capital (WACC).
Question 5 - What is your final estimate for the cost of equity, rs?
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