The market value of Growth Company’s assets

Growth Company’s current share price is $20 and is expected to pay a $1 dividend per share next year. After that, the firm’s dividends are expected to grow at a rate of 4% per year.

a. What is an estimate of Growth Company’s cost of equity?

b. Growth Company also has preferred stock outstanding that pays a $2 per share fixed dividend. If this stock is currently priced at $28, what is Growth Company’s cost of preferred stock?

c. Growth Company has existing debt issued three years ago with a coupon rate of 6%. The firm just issued new debt at par with a coupon rate of 6.5%. What is Growth Company’s cost of debt?

d. Growth Company has 5 million common shares outstanding and 1 million preferred shares outstanding, and its equity has a total book value of $50 million. Its debt has a market value of $20 million. If Growth Company’s common and preferred shares are priced at $20 and $28, respectively, what is the market value of Growth Company’s assets?

e. Growth Company faces a 35% tax rate. Given the information in parts (a) through (d), and your answers to those problems, what is Growth Company’s WACC?

Solution: