[A] Ecology Labs, Company, will pay a dividend of $3 / share in the next twelve months (D1). The required rate of return (Ke) is 10% and the constant growth rate is 5%.
(a) Calculate P0.
[For parts b, c, d in this problem, all variables remain same except the one specifically changed. Every question is independent of the others.]
(b) Suppose Ke, the required rate of return, goes up to 12%; what will be the new value of P0?
(c) Suppose the growth rate (g) goes up to 7%; what will be the new value of P0? Ke goes back to its original price of 10%.
(d) Suppose D1 is $3.50; what will be the new value of P0? Suppose Ke is at its original value of 10% and g goes back to its original value of 5%.
[B] United Business Forms' capital structure is as follows:
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Debt
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35%
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Preferred stock
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15
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Common equity
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50
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The after tax cost of debt is 7%, cost of preferred stock is 10%, & the cost of common equity [in the form of retained earnings] is 13%.
Compute United Business forms' weighted average cost of capital in a manner similar to Table 11 - 1 on page 328.
[C] As an option to the capital structure shown in Problem 17 for United Business Forms, an outside consultant has suggested the following modifications.
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Debt
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65%
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Preferred stock
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5
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Common equity
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30
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Under this new, more debt-oriented arrangement, the after tax cost of debt is 9.8%; the cost of preferred stock is 12%; and the cost of common equity [in the form of retained earnings] is 15.5%.
Recalculate United Business Forms' weighted average cost of capital. Determine which plan is optimal in terms of minimizing the weighted average cost of capital?