Start with the partial model in the file Ch09 P18 Build a Model.xlsx on the textbooks Web site. The stock of Gao Computing sells for $50, and last years dividend was $3.13. Security analysts are projecting that the common dividend will grow at a rate of 7% a year. A flotation cost of 10% would be required to issue new common stock. Gaos preferred stock sells for $32.61, pays a dividend of $3.30 per share, and new preferred stock could be sold with a flotation cost of 8%. The firm has outstanding bonds with 20 years to maturity, a 12% annual coupon rate, semiannual payments, $1,000 par value. The bonds are trading at $1,171.59. The tax rate is 25%. The market risk premium is 6%, the risk-free rate is 6.5%, and Gaos beta is 1.2. In its cost-of-capital calculations, Gao uses a target capital structure with 45% debt, 5% preferred stock, and 50% common equity.

a) Calculate the cost of each capital componentin other words, the after-tax cost of debt, the cost of preferred stock (including flotation costs), and the cost of equity (ignoring flotation costs). Use both the CAPM method and the dividend growth approach to find the cost of equity.

b) Calculate the cost of new stock using the dividend growth approach.

c) Assuming that GAO will not issue new equity and will continue to use the same target capital structure, what is the companys WACC?

= x Net P. 32 Cost of debt: 33 34 N = 40 35 PMT = $60.00 36 PV = $1,171.59 37 FV = $1,000.00 38 39 Semiannual yield = RATE = 40 41 Annual B-Tra 42 43 B-T ra (1 -T) A-Tra 44 0% 45 46 Cost of preferred stock (including flotation costs): 47 48 Det 1 ret 49 50 51 Cost of common equity, dividend growth approach (ignoring flotation costs): 52 53 D / PO 9 rs 54 55 56 Cost of common equity, CAPM: 57 58 b x RPM rs 59 60 61 62 b. Calculate the cost of new stock using the dividend growth approach (include flotation costs). 63 64 D.* (1 +9) 1 P(1 - F) + 9 65 66 67 c. Assuming that Gao will not issue new equity and will continue to use the same capital structure, what is the 68 company's WACC? 69 = 70 W 71 W 72 Ws 45.0% 5.0% 50.0% 100.0% 73 74 75 76 77 W. * A-Tro + W: Tp W xr WACC = x Net P. 32 Cost of debt: 33 34 N = 40 35 PMT = $60.00 36 PV = $1,171.59 37 FV = $1,000.00 38 39 Semiannual yield = RATE = 40 41 Annual B-Tra 42 43 B-T ra (1 -T) A-Tra 44 0% 45 46 Cost of preferred stock (including flotation costs): 47 48 Det 1 ret 49 50 51 Cost of common equity, dividend growth approach (ignoring flotation costs): 52 53 D / PO 9 rs 54 55 56 Cost of common equity, CAPM: 57 58 b x RPM rs 59 60 61 62 b. Calculate the cost of new stock using the dividend growth approach (include flotation costs). 63 64 D.* (1 +9) 1 P(1 - F) + 9 65 66 67 c. Assuming that Gao will not issue new equity and will continue to use the same capital structure, what is the 68 company's WACC? 69 = 70 W 71 W 72 Ws 45.0% 5.0% 50.0% 100.0% 73 74 75 76 77 W. * A-Tro + W: Tp W xr WACC