Pierce Industries stock has a beta of 1.26. The company just paid a dividend of
ID: 2781986 • Letter: P
Question
Pierce Industries stock has a beta of 1.26. The company just paid a dividend of $.76, and the dividends are expected to grow at 5.1 percent. The expected return on the market is 11.6 percent, and Treasury bills are yielding 5.1 percent. The most recent stock price is $81.25.
a. Calculate the cost of equity using the dividend growth model method. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
Cost of equity %
b. Calculate the cost of equity using the SML method. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
Cost of equity
Hankins, Inc., is considering a project that will result in initial aftertax cash savings of $5.2 million at the end of the first year, and these savings will grow at a rate of 3 percent per year indefinitely. The firm has a target debt–equity ratio of .51, a cost of equity of 13.1 percent, and an aftertax cost of debt of 6.5 percent. The cost-saving proposal is somewhat riskier than the usual project the firm undertakes; management uses the subjective approach and applies an adjustment factor of +3 percent to the cost of capital for such risky projects.
Calculate the WACC. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
WACC %
What is the maximum cost the company would be willing to pay for this project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Present value $
Explanation / Answer
a) Cost of equity = D0 x (1 + g) / P + g = 0.76 x (1 + 5.1%) / 81.25 + 5.1% = 6.08%
b) Cost of equity = Rf + beta x (Rm - Rf) = 5.1% + 1.26 x (11.6% - 5.1%) = 13.29%
c) WACC = wd x kd + we x ke
= 0.51 / (1 + 0.51) x 6.5% + 1 / (1 + 0.51) x 13.1%
= 10.87%
For risky project, WACC = 10.87 + 3 = 13.87%
Max Price = D1 / (r - g) = 5.2 / (13.1% - 3%) = $47.84 million