Problem set 9
Pickerington Communications Inc. (PCI) has developed a powerful server that would be used for the company’s internet activities. The company has the following capital structure, which is considered optimal. Debt is 30%, preferred stock is 10%, and common stock is 60%. PCI’s tax rate is 25%, and investors expect earnings and dividends to grow at a constant rate of 6% in the future. The company paid a dividend of $3.70 per share last year (D0), and its stock currently sells at a price of $60 per share. Ten-year Treasury bonds yield 6%, the market risk premium is 5%, and PCI’s beta is 1.3.
The following information is available for managerial finance analysis:
Preferred stock: New preferred stock could be sold to the public at a price of $100 per share, with a dividend of $9. Flotation costs per share is $5.
Debt: The company’s long-term debt has a yield to maturity of 9% i.e., the before-tax cost of debt is 9%.
Common stock: All common stock will be raised internally by reinvesting earnings.
Identify the major capital structure components for Pickerington Communications and give their respective weights.
Calculate the company’s after-tax cost of debt.
Calculate the cost of preferred stock.
Calculate the company’s cost of common stock using both CAPM method and the dividend growth method.
What is the company’s weighted average cost of capital (WACC)?
The company believes that it can issue long-term corporate bonds next year that will have a yield to maturity of 13% and a coupon rate of 10%. However, the company is not sure about the tax rate for next year. Calculate the after-tax cost of debt under each of the following conditions:
i. the tax rate remains at 25%
ii. the tax rate reduces to 20%
iii. the tax rate increases to 35%
The company’s management is meeting today to discuss ways to minimize its cost of capital.
7. Identify three factors that the management of PCI cannot control and three factors that it can use to control its cost of capital.
Submit your answers in a Word document.