Cost of Capital The stock of Apple Inc. sells for $169.24, and last year’s divid
ID: 2790293 • Letter: C
Question
Cost of Capital The stock of Apple Inc. sells for $169.24, and last year’s dividend was $2.52. A flotation cost of 3.15% would be required to issue new common stock. Assume Apple plans to issue $1,000 million preferred stock that pays an annual preferred dividend of $3.77 per share. The new preferred stock could be sold at a price to net the company $100 per share (inclusive of flotation costs). Security analysts are projecting that the common dividend will grow at a constant rate of 5.8% a year. The firm can issue additional long- term debt at an interest rate (or a before-tax cost) of 4.5%, and its marginal tax rate is 25%. The market risk premium is 3.61%, the risk-free rate is 2.33%, and Apple’s beta is 1.40. The cost of short term debt for Apple is 0.5%. Part 1: Component Costs A) Calculate the after-tax cost of short-term debt B) Calculate the after-tax cost of long-term debt C) Calculate the cost of preferred stock D) Calculate the cost of internal equity using both the CAPM method and the dividend growth approach (8 Points) Part 2: Capital Structure Visit the following website: http://investor.apple.com/secfiling.cfm?filingID=320193-17- 70&CIK=320193#A10-K20179302017_HTM_S63EA20E94A5151458E162BF17BAE3A6F From “Item 6. Selected Financial Data,” identify the amount of short-term debt for 2017 (Commercial paper), long-term debt for 2017 (Total term debt minus Commercial paper), and common equity for 2017 (Total shareholders’ equity) for section E below: E) Calculate the capital structure weights if the Apple plans to raise capital according to current values, in the future (8 points) F) Calculate the weighted average cost of capital G) Calculate the cost of new common stock (external equity) H) Calculate the weighted average cost of capital for new common stock
Explanation / Answer
a) Part 1: Component Costs A) Calculate the after-tax cost of short-term debt After Tax Cost of short term debt = 0.5% x (1-25%) 0.38% B) Calculate the after-tax cost of long-term debt After Tax Cost of Long term debt = 4.5% x (1-25%) 3.38% C) Calculate the cost of preferred stock Cost of Preferred Stock = $3.77 / $100 3.77% D) Calculate the cost of internal equity using both the CAPM method and the dividend growth approach Using CAPM Cost of equity = Rf + Beta x MRp Cost of equity = 2.33% + 1.40 x 3.61% 7.38% Dividend growth approach Cost of equity = D0 x (1+g)/P0 ) + g Cost of equity =( 2.52 x (1+5.8%)/$169.2+ 5.8% 7.38%