DEF plc. is a leading producer of mountain sports equipment. The company iscurrently evaluating a new product: self-heating hiking boots. The CEO and her teamhave already estimated the projects’ cash flows and the initial cost required for theproject is €5,000,000. The company will finance the project by issuing corporatebonds worth of €1,500,000, issuing preferred stock worth of €500,000 and theremaining €3,000,000 will be financed from retained earnings. Also note that:

(1) DEF has recently issued a 15-year, 6% coupon corporate bond, that payscoupon twice per year. The bond face value is €1,000 and the price is €954.
(2) The firm uses short-term debt of €200,000 to finance working capitalrequirements.
(3) The company’s preferred stock is traded at €4.50, pays 30% of €1 par asannual dividend, twice per year. In case DEF issues new preferred stock,issuance costs will be 5%.
(4) Government bonds currently offer 2%, and the market risk premium isestimated at 6%. The firm’s beta is 1.3.
(5) DEF last dividend (D0) to common shareholders was €0.35, having steadilyincreased from 0.28 four years ago. DEF’s current common stock price is€11.

(6) DEF’s tax rate is 20 percent.

1. Calculate DEF’s cost of retained earnings using the DDM approach
2. What is your final estimate for the cost of retained earnings? Explain.
3. Calculate DEF’s weighted average cost of capital (WACC).
4. Assume that DEF plc. has several production divisions, each one producing differentproducts. Should the overall WACC as calculated in (3) above be used for all thesedivisions? Analyze

Answer rating: 100% (QA)

Cost of equity as per CAPM Rf beta x Rmp 2 13 x 6 980 Growth rate in d... View the full answer