PROBLEM 4 Masco Oil and Gas Company is a very large company with common stock listed on...

Free

80.2K

Verified Solution

Question

Finance

PROBLEM 4
Masco Oil and Gas Company is a very large company with commonstock listed on the New York Stock Exchange and bonds traded overthe counter. As of the current balance sheet, it has three bondissues outstanding:
$150 million of 10 percentseries......................       2021
$50 million of 7 percent series..........................       2015
$75 million of 5 percent series..........................       2011
The vice president of finance is planning to sell $75 million ofbonds next year to replace the debt due to expire in 2011. Presentmarket yields on similar Baa-rated bonds are 12.1 percent. Mascoalso has $90 million of 7.5 percent noncallable preferred stockoutstanding, and it has no intentions of selling any preferredstock at any time in the future. The preferred stock is currentlypriced at $80 per share, and its dividend per share is $7.80.
The company has had very volatile earnings, but its dividendsper share have had a very stable growth rate of 8 percent and thiswill continue. The expected dividend (D₁) is$1.90 per share, and the common stock is selling for $40 per share.The company’s investment banker has quoted the following flotationcosts to Masco: $2.50 per share for preferred stock and $2.20 pershare for common stock.
On the advice of its investment banker, Masco has kept its debtat 50 percent of assets and its equity at 50 percent. Masco sees noneed to sell either common or preferred stock in the foreseeablefuture as it has generated enough internal funds for its investmentneeds when these funds are combined with debt financing. Masco’scorporate tax rate is 25 percent.
Compute the cost of capital for the following:
a.      Bond (debt)(K_d).
b.     Preferred stock (K_p).
c.     Common equity in the form of retained earnings(K_e).
d.      Newcommon stock (K_n).
e.     Weighted average cost of capital.

Answer & Explanation Solved by verified expert

4.2 Ratings (828 Votes)

a.Cost of Bond,Kd

After=tax yield on the bonds=

12.1%*(1-25%)=

9.08%

b. Cost of preferred stock,Kp

$ dividend/Net proceeds per share

Where, Net proceeds= Current market price-Flotation costs

ie. 7.80/(80-2.50)=

10.06%

c. Common equity in the form of retained earnings (K_e).

ke=(Next dividend/Current maket price)+Growth rat eof dividends

ie. Ke=(D1/P0)+g

ie.Ke=(1.90/40)+8%

12.75%

d.Cost of New common stock (K_n).

kn=(Next dividend/Net proceeds )+Growth rat eof dividends

ie.Kn=(1.90/(40-2.20))+8%=

13.03%

e. WACC

Given that

IT has generated enough internal funds for its investment needs when these funds are combined with debt financing

Masco sees no need to sell either common or preferred stock in the foreseeable future

we will use debt & retained Earnings only ,both 50%, to find the WACC,

so, WACC=(Wt.d*Kd)+(Wt.e*Ke)

ie.(50%*9.08)+(50%*12.75%)=

10.92%

Get Answers to Unlimited Questions

Join us to gain access to millions of questions and expert answers. Enjoy exclusive benefits tailored just for you!

Membership Benefits:

Unlimited Question Access with detailed Answers
Zin AI - 3 Million Words
10 Dall-E 3 Images
20 Plot Generations
Conversation with Dialogue Memory
No Ads, Ever!
Access to Our Best AI Platform: Flex AI - Your personal assistant for all your inquiries!

Become a Member

Transcribed Image Text

PROBLEM 4Masco Oil and Gas Company is a very large company with commonstock listed on the New York Stock Exchange and bonds traded overthe counter. As of the current balance sheet, it has three bondissues outstanding:$150 million of 10 percentseries...................... 2021$50 million of 7 percent series.......................... 2015$75 million of 5 percent series.......................... 2011The vice president of finance is planning to sell $75 million ofbonds next year to replace the debt due to expire in 2011. Presentmarket yields on similar Baa-rated bonds are 12.1 percent. Mascoalso has $90 million of 7.5 percent noncallable preferred stockoutstanding, and it has no intentions of selling any preferredstock at any time in the future. The preferred stock is currentlypriced at $80 per share, and its dividend per share is $7.80.The company has had very volatile earnings, but its dividendsper share have had a very stable growth rate of 8 percent and thiswill continue. The expected dividend (D1) is$1.90 per share, and the common stock is selling for $40 per share.The company’s investment banker has quoted the following flotationcosts to Masco: $2.50 per share for preferred stock and $2.20 pershare for common stock.On the advice of its investment banker, Masco has kept its debtat 50 percent of assets and its equity at 50 percent. Masco sees noneed to sell either common or preferred stock in the foreseeablefuture as it has generated enough internal funds for its investmentneeds when these funds are combined with debt financing. Masco’scorporate tax rate is 25 percent.Compute the cost of capital for the following:a. Bond (debt)(Kd).b. Preferred stock (Kp).c. Common equity in the form of retained earnings(Ke).d. Newcommon stock (Kn).e. Weighted average cost of capital.