Today is January 1, 2013. As of today, Everest International’s (EI)
capital structure is comprised of common equity, preferred stock and long-term
debt. Few days ago, EI raised $1,025,000 issuing long-term bond which matures
in 10 years. It pays 8.5% semi-annual coupon to the bond holders and the face
value of the bond is $1,100,000. Everest International is expected to pay $1.75
dividend next year and the common dividend will grow at an annual rate of 7%
forever. Currently, EI’s common stock is trading for $34, there are 45,000
common shares. EI's beta is 2.12.It is considering starting a new project. If
it starts the new project, it will issue new common equity and there will be an
11% flotation cost to issue new equity. Assume that the price of new common
stock will be same as the current common share price. EI Just issued 15,000
preferred shares at $25 per share with a commitment to pay $1.85 dividend per
year. The firm’s marginal tax rate is 35%. The market risk premium is 4.5% and
the risk-free rate is 3.25%.
a. What is the before tax cost of debt?
b. Calculate the after tax cost of debt.
c. What is the cost of preferred stock?
d. Calculate the cost of equity using discounted cash flow method.
e. As you know that EI is considering issuing new equity. If it issues
new common equity, what will be the cost of new equity?
f. What is the cost of common equity using the CAPM approach?
g. What is the weighted average cost of capital? (Hint: use cost of
equity you have computed using the CAPM as cost of equity).
TUTORIAL PREVIEW
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a.
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Before tax cost of debt:
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Nper = 10 x 2 =
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20
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PMT = 1100000x8.5%x1/2=
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46750
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PV =
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-1025000
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FV =
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1,100,000
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