In order to calculate the cost of capital, it is necessary to accurately assess the capital structure of a firm. Below is information for estimating the cost of capital for JKM Company.
Portion of the Balance Sheet for JKM Company as of January 1, 2016.
Long-term debt (bonds, at par) $10,000,000
Preferred Stock (par $5) $12,000,000
Common Stock ($10) $20,000,000
Retained earnings 8,000,000
Total debt and equity $50,000,000
a. The bonds have a 4 percent coupon rate, payable semiannually, and a par value of $1,000. They mature on January 1, 2020. The yield to maturity is 12 percent, so the bonds now sell below par. What is the current market value of the firm's debt?
b. The Company has been growing at a 10% rate, and it just paid a dividend of D0 $3.00. Due to a new product, JKM expects to achieve a dramatic increase in its short-run growth rate, to 20 percent annually for the next 2 years. After this time, growth is expected to return to the long-run constant rate of 10 percent. If the rate of return were 15%, what would be the market value of equity?
c) What should the dividend yield be today?
d) If the preferred stock were selling for $12 per share, what would be the market capital structure today?
e) Assume the dividend per share on preferred stock is $1.68; what is the required rate of return on the preferred stock.
f) Calculate the Weighted Average Cost of Capital.
g) Suppose JKM is evaluating the five projects (below) that are in a different risk class for adoptions.
1-Which projects are accepted if the corporate cost of capital is used?
2-Which projects are accepted if the projects cost of capital is used? Graph the result of sections (1) and (2) and discuss the results.
Projects IRR Beta
1 17% 2.2
2 18% 1.7
3 16% 1.3
4 13% 1.0
5 10% 1.1
Risk-free rate 5%
Risk Premium 6%