Chen Chocolate Company’s EPS in 2016 was $1.25, and in 2011 it was $0.75. The company’s payout ratio is 50%, and the stock is currently valued at $37.75. Flotation costs for new equity will be 15%. Net income in 2017 is expected to be $18 million.
The company’s investment banker estimates that it could sell 10-year semiannual bonds with a coupon rate of 5%. The face value would be $1,000 and the flotation costs for a bond issue would be 1%. The market- value weights of the firm’s debt and equity are 25% and 75%, respectively. The firm faces a 35% tax rate.
a. Based on the five-year track record, what is Chen’s EPS growth rate? What will the dividend be in 2017?
b. Calculate the firm’s cost of retained earnings and the cost of new common equity.
c. Calculate the break-point associated with retained earnings.
d. What is the firm’s after-tax cost of new debt?
e. What is the firm’s WACC with retained earnings? With new common equity?
f. Create a scatter chart that shows the firm’s marginal WACC as a step function. The x-axis should go to at least $20 million. Be sure to fully label the chart, including a data label with leader lines that shows the value of the break-point.