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Finance

1. Zapata Enterprises finances its operations through bonds and common stock. It has $3 million in bonds yielding 14% and $7 million in stock expected to pay $500,000 in dividends with 11% annual growth. The problem is to calculate the overall weighted average cost of capital. 2. Given bond and stock amounts for Zapata, along with bond yield and stock dividend information, the task is to find the cost of capital with a 40% corporate tax rate. 3. International Copy Machines was priced at $300/share in 20X1 based on expected $3 dividend and 20% growth. Due to economic changes, growth is now expected to be 15% in

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820 views1 page

Finance

1. Zapata Enterprises finances its operations through bonds and common stock. It has $3 million in bonds yielding 14% and $7 million in stock expected to pay $500,000 in dividends with 11% annual growth. The problem is to calculate the overall weighted average cost of capital. 2. Given bond and stock amounts for Zapata, along with bond yield and stock dividend information, the task is to find the cost of capital with a 40% corporate tax rate. 3. International Copy Machines was priced at $300/share in 20X1 based on expected $3 dividend and 20% growth. Due to economic changes, growth is now expected to be 15% in

Uploaded by

florentina
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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1. Zapata Enterprises is financed by two sources of funds: bonds and common stock.

The

cost of capital for funds provided by bonds is ki, and ke is the cost of capital for equity

funds. The capital structure consists of B dollars’ worth of bonds and S dollars’ worth of

stock, where the amounts represent market values. Compute the overall weighted average

of cost of capital, ko.

2. Assume that B (in Problem 1) is $3 million and S is $7 million. The bonds have a 14 percent yield to
maturity, and the stock is expected to pay $500,000 in dividends this year.

The growth rate of dividends has been 11 percent and is expected to continue at the same

rate. Find the cost of capital if the corporation tax rate on income is 40 percent.

3. On January 1, 20X1, International Copy Machines (ICOM), one of the favorites of the

stock market, was priced at $300 per share. This price was based on an expected dividend

at the end of the year of $3 per share and an expected annual growth rate in dividends of

20 percent into the future. By January 20X2, economic indicators have turned down, and

investors have revised their estimate for future dividend growth of ICOM downward to

15 percent. What should be the price of the firm’s common stock in January 20X2?

Assume the following:

a. A constant dividend growth valuation model is a reasonable representation of the way

the market values ICOM.

b. The firm does not change the risk complexion of its assets nor its financial leverage.

c. The expected dividend at the end of 20X2 is $3.45 per share.

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