1ARollins Corporation is estimating its WACC Its target capi

1A.Rollins Corporation is estimating its WACC. Its target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 9.0 percent coupon, paid semiannually, a current maturity of 20 years, and sell for the par value, $1,000. The firm\'s marginal tax rate is 30 percent.
What is Rollins\' component cost of debt? Express your answer in percentage (without the % sign) and round it to two decimal places.

1B. Rollins Corporation is estimating its WACC. Its target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Rollins\' beta is 1.2 , the risk-free rate is 4 percent, and the market risk premium is 6 percent. Rollins is a constant-growth firm which just paid a dividend of $2.00, sells for $ 29 per share, and has a growth rate of 6 percent. The firm\'s policy is to use a risk premium of 5 percentage points when using the bond-yield-plus-risk-premium method to find r_s. The firm\'s marginal tax rate is 38 percent.
What is Rollins cost of equity when using the CAPM approach? Express your answer in percentage (without the % sign) and round it to two decimal places.

Solution

Answer 1 A.

Face Value = $1,000
Current Price = $1,000
Annual Coupon Rate = 9.0%

Since, face value and current price of the bond are equal, the stated rate and yield to maturity are also equal.

Pretax Cost of Debt = 9.0%
After-tax Cost of Debt = 9.0% * (1 - 0.30)
After-tax Cost of Debt = 6.30%

So, Rollins’ component cost of debt is 6.30%

Answer 1 B.

Beta = 1.20
Risk-free Rate = 4.0%
Market Risk Premium = 6%

Cost of Equity = Risk-free Rate + Beta * Market Risk Premium
Cost of Equity = 4.0% + 1.20 * 6.0%
Cost of Equity = 11.20%

So, Rollins’ component cost of equity using CAPM is 11.20%