As the Capital Budgeting Manager of Regal Corp., you are engaged in determining the Weighted Average Cost of Capital for the firm for the upcoming year. You have the following balance sheet data based on book values:
Long-term debt ($1000 par,20 years to maturity) $25.0 million
Preferred stock($100 par,13% annual dividend) $ 6.25 million
Common stock (2 million shares outstanding) $50.0 million
Regal's outstanding bonds, which pay interest semiannually, have a coupon rate of 11.4% and are currently priced at $1250. New debt will have maturity and other characteristics such that required return on new debt will be 147 basis points more than the requirement on outstanding debt. Regal can raise any amount of new debt under above conditions. New debt will be privately placed and there will be no flotation costs.
Regal's preferred is currently priced to yield 16.25% Regal has been advised by its investment bankers that new preferred can be sold at par ($100) by setting the dividend rate to match current yield requirement of 16.25% on preferred stock. However, there will be a 2.25% (of price) flotation cost for new preferred issues. Investment Bankers have advised Regal that it can issue any amount of new preferred under the above conditions. Regal will continue to be in the 34% marginal tax bracket.
Regal's common stock is currently selling for $44.375 per share. The beta of common has been computed as 1.65. Dividend expected a year from now is estimated to be $4.7050 per share, representing a 58% payout. The payout is expected to remain unchanged. The expected ROE is 18%. The estimates on T-bond rate and risk premium on the market portfolio are 5.4% and 8% respectively. Investment bankers have advised that new common stock can be issued at current price of $44.375 per share, but there will be a 15% (of price per share) flotation cost.
Assume that capital markets are efficient and that prices of securities are are fair. You consider Regal's current capital structure based on market values of its securities (bond. Preferred stock and common stock)to be optimum and on target.
Answer the following questions using the above information
a. What is Regal's optimum, target capital structure?
b. What is Regal's after-tax cost of new debt?
c. What is Regal's after-tax cost of new preferred stock?
d. What is Regal's cost of retained earnings using the CAPM/SML?
e. What is the expected growth rate of Regal's dividends using the Earnings Retention Model?
f. What is Regal's cost of retained earnings using the DCF model?
g. What is Regal’s Weighted Average Cost of Capital using cost of Retained earnings for cost of equity capital?
h. What is Regal’s cost of equity raised by selling new common stock, using the DCF method?
i. What is Regal’s Weighted Average Cost of Capital using cost of equity cost for cost?