Robbins Corporation has a target capital structure
consisting of 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Assume the firm has insufficient retained earnings to fund the equity portion of its capital budget. Its bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sell for P1,000. The firm could sell, at par, P100 preferred stock that pays a 12 percent annual dividend, but flotation costs of 5 percent would be incurred. Cost of Capital – Exercise 1
Robbins’ beta is 1.2, the risk-free rate is 10 percent,
and the market risk premium is 5 percent. Robbins is a constant growth firm that just paid a dividend of P2.00, sells for P27.00 per share, and has a growth rate of 8 percent. The firm’s policy is to use a risk premium of 4 percentage points when using the bond-yield-plus-risk-premium method to find ks. Flotation costs on new common stock total 10 percent, and the firm’s marginal tax rate is 40 percent. Cost of Capital – Exercise 1
a. What is Robbins’ component cost of debt?
Component cost of debt = 7.2%
Cost of Capital – Exercise 1
b. What is Robbins’ cost of preferred stock?
Cost of Preferred Stock = 12.6%
Cost of Capital – Exercise 1
c. What is Robbins’ cost of retained earnings using
the CAPM approach?
Cost of Retained Earnings (CAPM) =
16.0% Cost of Capital – Exercise 1
d. What is the firm’s cost of retained earnings using
the DCF approach?
Cost of Retained Earnings (DCF) = 16.0%
Cost of Capital – Exercise 1
e. What is Robbins’ cost of retained earnings using
the bond-yield-plus-risk-premium approach?
Cost of Retained Earnings (BYPRP) = 16.0%
Cost of Capital – Exercise 1
f. What is Robbins’ WACC, if the firm has insufficient
retained earnings to fund the equity portion of its capital budget?
WACC if insufficient RE = 14.1%
Cost of Capital – Exercise 2
The Galaxy Advertising Company has a marginal tax rate of
40 percent. The company can raise debt at a 12 percent interest rate and the last dividend paid by Galaxy was P0.90. Galaxy’s common stock is selling for P8.59 per share, and its expected growth rate in earnings and dividends is 5 percent. If Galaxy issues new common stock, the flotation cost incurred will be 10 percent. Galaxy plans to finance all capital expenditures with 30 percent debt and 70 percent equity. Cost of Capital – Exercise 2
a. What is Galaxy’s cost of retained earnings if it can
use retained earnings rather than issue new common stock?
Cost of Retained Earnings = 16.0%
Cost of Capital – Exercise 2
b. What is the cost of common equity raised by
selling new stock?
Cost of Common Equity = 17.22%
Cost of Capital – Exercise 2
c. What is the firm’s weighted average cost of capital
if the firm has sufficient retained earnings to fund the equity portion of its capital budget?