Question

(14 points) A financial analyst determines that Cyclone Company has $54 million of interest bearing debt outstanding and 3,800,000 common shares outstanding at the end of 2019. She also estimates that Cyclone’s after-tax cost of debt is 6.30% and that its cost of equity using the capital asset pricing model is 9.72%. The company pays a $2.00 dividend and has a current stock price $45.60 per share. The company has a marginal income tax rate of 37%. Required: a. Compute the company's weighted average cost of capital. b. Assuming that Cyclone’s dividend will last into perpetuity what cost of equity capital is inferred by the current stock price? c. Assuming that the financial analyst has properly calculated the cost of equity capital and that Cyclone will pay a dividend of $2.70 next year what growth rate is implied by the current stock price?

Answer 1

Answer:

CYCLONE COMPANY

a.                                                          Value                   r               Harsh total

      Interest bearing debt                   $54,000,000     0.03969    2,143,260

    Common share(3,800,000*$45.60)173,280,000   0.0972      16,842,816

                                                            227,280,000                        18,986,076

Weighted average cost of capital =  18,986,076/227,280,000 =

                                                       = 0.0835 = 8.35%

r for debt =  6.30%*( 1 - 0.37)  = 3.969% = 0.03969

b.  cost of equity  =   D/P   =   $2/$45.60 = 0.0439 =  4.49%

c.     D1  = D(1+g)

     $2.70 =  $2(1 + g)

      1+g  =  $2.70/$2

     1 + g = 1.35

    g = 1.35 - 1  =  0.35

    g =  35%

Explanation: