Please do 4 and 5

4) Assuming the companys current capital structure is its target capital structure, if Foliage Companyhas the following capital structure, what is the firms weighted average cost of capital (WACC)? (Usehighest cost of equity estimate in your calculations.) Debt $100,000,000 Preferred Stock 20,000,000 Common Stock 200,000,000

5) If Foliage changes its target capital structure to increase the amount of debt by 50% and reduce the amount of common equity by 25% (and does this by borrowing $50,000,000 and using the borrowedfunds to retire $50,000,000 of common stock), what is its new WACC? Why did the WACC decline? Comment

--------------Part 1

1) Foliage Companys 10 year bonds, which have a coupon of 4%, currently trade in the market at a 4.8%yield to maturity. If its marginal tax rate is 35%, what is the companys after-tax cost of debt?

2) Foliage Companys investment bankers told the company that it could issue a preferred stock with adividend of $5.50 and a price of $98. Issuance costs would be 1.2%. What is the companys cost ofpreferred stock? 3) Foliage Companys future earnings and dividends are expected to grow at a constant rate of 3% peryear. Its common stock currently trades at $15 per share. It paid a dividend of $2 per share yesterday.The company has a beta of 1.75. The current risk free rate is 2%, and the required return on the marketis assumed to be 12%. The company can issue bonds at a 4.8% yield to maturity. a) Calculate the firms cost of equity using CAPM.

b) Calculate the firms cost of equity using the Dividend Yield + Growth rate model.

c) Calculate the firms cost of equity using the Bond Yield + Risk premium approach (assume the mid point of the risk premium range of 3-5%).

d) Based on the above, what do you want to assume for the companys estimated cost of equity?

----------------Answers to the first part

1) Cost of Debt (after tax) = [ Interest (1 - Tax Rate) + (Redemption Value - Net Proceeds)/Life ] / (Redemption Value + Net Proceeds)/2

Yield To Maturity is a available rate of return of a bond if it is purchased and hold till maturity period.

YTM is such discount rate at which PV of Future Inflows of bond will equal to the amount invested in such bond (i.e. PV of OUtflow or Current Market Price of Bond).

Assumed Par Value of BOnd = $100

Current Market Price of Bond = Coupon Interest x PVIFA (4.8%, 10) + Maturity Proceeds x PVIF (4.8%, 10)

= ($4 x 7.7973) + $100 x 0.6257 = $31.189 + 62.57 = $93.76

Cost of Debt (after tax) = [ Interest (1 - Tax Rate) + (Redemption Value - Net Proceeds)/Life ] / (Redemption Value + Net Proceeds)/2

= [ $4 (1 - 0.35) + ($100 - $93.76) / 10 ] / ($100 + $93.76)/2

= $2.6 + $0.624 / $96.88 = 0.03327 or 3.327%

Cost of Debt (after tax) = 3.327%

2) Cost of Preferred Stock = Preference Dividend / Net Proceeds x 100

= $5.5 / $96.80 x 100 = 5.68%

Assumed Par Value of a Preferred Stock = $100

Issuance Cost = $100 x 1.2% = $1.2

Net Proceeds = Market Value - Issuance Cost = $98 - $1.2 = $96.80

3) Cost of Equity as per CAPM = Risk Free Return + Beta of security x (Market Return - Risk Free Return)

= 2% + 1.75 (12% - 2%) = 19.50%

Cost of Equity (Dividend Yield + Growth Model) = Expected NExt Year Dividend / CUrrent Market Price + growth

Growth Rate (g) = 3%

Current Market Price of Stock (P) = $15

Dividend Paid (D0) = $2

Expected Next Year Dividend = $2 x (1 + Growth Rate) = $2 x 1.03 = $2.06

Cost of Equity = $2.06 / $15 + 0.03 = 0.1673 or 16.73%