Here is the condensed 2021 balance sheet for Skye Computer Company (in thousands of dollars):
2021
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Current assets $1,400
Net fixed assets 2,600
Total assets $4,000
Accounts payable and accruals $ 800
Short-term debt 200
Long-term debt 900
Preferred stock (10,000 shares) 200
Common stock (40,000 shares) 925
Retained earnings 975
Total common equity $1,900
Total liabilities and equity $4,000
Skye's earnings per share last year were $2.65. The common stock sells for $50.00, last year's dividend (D0) was $1.65, and a flotation cost of 9% would be required to sell new common stock. Security analysts are projecting that the common dividend will grow at an annual rate of 10%. Skye's preferred stock pays a dividend of $2.75 per share, and its preferred stock sells for $25.00 per share. The firm's before-tax cost of debt is 11%, and its marginal tax rate is 25%. The firm's currently outstanding 11% annual coupon rate, long-term debt sells at par value. The market risk premium is 4%, the risk-free rate is 5%, and Skye's beta is 1.544. The firm's total debt, which is the sum of the company's short-term debt and long-term debt, equals $1.1 million.
The data has been collected in the Microsoft Excel file below. Download the spreadsheet and perform the required analysis to answer the questions below. Do not round intermediate calculations. Round your answers to two decimal places.
1. Calculate the cost of each capital component, that is, the after-tax cost of debt, the cost of preferred stock, the cost of equity from retained earnings, and the cost of newly issued common stock. Use the DCF method to find the cost of common equity.
1. After-tax cost of debt: 8.25%
2. Cost of preferred stock: 11%
3. Cost of retained earnings: 13.63%
4. Cost of new common stock: 13.98%
5. Now calculate the cost of common equity from retained earnings, using the CAPM method.
11.176%
6. What is the cost of new common stock based on the CAPM? (Hint: Find the difference between re and rs as determined by the DCF method, and add that differential to the CAPM value for rs.)
11.53%
7. If Skye continues to use the same market-value capital structure, what is the firm's WACC assuming that (1) it uses only retained earnings for equity and (2) if it expands so rapidly that it must issue new common stock? (Hint: Use the market value capital structure excluding current liabilities to determine the weights. Also, use the simple average of the required values obtained under the two methods in calculating WACC.)
WACC1: ______ % ?
WACC2: _______% ?
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NOTE: FYI for tutor, I only need help with the last question, 7. The answers below were attempted and are incorrect.
WACC1 = 11.52
WACC2 = 12.02
WACC1 = 9.93
WACC2 = 11.10
WACC1 = 8.88%
WACC2 = 9.64%
