Home /
Expert Answers /
Finance /
show-me-the-steps-to-solve-during-the-last-few-years-dannys-fabulous-fried-chicken-competitor-pa416

Show me the steps to solve During the last few years, Danny’s Fabulous Fried Chicken Competitor, Delta Cubed has been to constrained by the high cost of capital to make many capital investments. Recently, though, capital costs have been declining, and the company has decided to look seriously at a major expansion program proposed by the marketing department. Assume that you are a consultant to Leigh Jones, the financial vice president. Your first task is to estimate Delta’s cost of capital. Jones has provided you with the following data, which she believes may be relevant to your task: • The firm’s tax rate is 35%. • The current price of Delta’s 12.5% coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity is $. Delta’s does not use short-term interest-bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost. • The current price of the firm’s 10%, $100 par value, quarterly dividend, perpetual preferred stock is $. Delta’s would incur flotation costs equal to 6% of the proceeds on a new issue. • Delta’s common stock is currently selling at $70 per share. Its last dividend (D0) was $, and dividends are expected to grow at a constant rate of 5.8% in the foreseeable future. Delta’s beta is 1.4, the yield on T-bonds is 5.6%, and the market risk premium is estimated to be 6%. For the own-bond-yield-plus-judgmental- risk-premium approach, the firm uses a 3.2% risk premium. • Delta’s target capital structure is 30% long-term debt, 10% preferred stock, and 60% common equity. Table: Group 1 Group 2 Group 3 Group 4 Group 5 Group 6 Group 7 Group 8 Bond price 1155.70 1152.55 1150.25 1145.77 1158.36 1122.65 1105.67 1118.26 Preferred Stock price 116.50 110.23 107.54 109.57 118.11 113.15 114.27 108.49 D0 2.88 3.02 3.12 3.31 3.22 3.40 3.29 3.35 To help you structure the task, Leigh Jones has asked you to answer the following questions. a. What is the market interest rate on Delta’s debt, and what is the component cost of this debt for WACC purposes? b. What is the firm’s cost of preferred stock? c. Delta doesn’t plan to issue new shares of common stock. Using the CAPM approach, what is Delta’s estimated cost of equity? d. (1) What is the estimated cost of equity using the discounted cash flow (DCF) approach? (2) Suppose the firm has historically earned 15% on equity (ROE) and has paid out 65% of earnings, and suppose investors expect simi lar values to obtain in the future. How could you use this information to estimate the future dividend growth rate, and what growth rate would you get? e. What is the cost of equity based on the own-bond- yield-plus-judgmental-risk-premium method? f. What is your final estimate for the cost of equity, rs? g. What is Delta’s weighted average cost of capital (WACC)? h. Delta is interested in establishing a new division that will focus primarily on developing new Internet-based projects. In trying to determine the cost of capital for this new division, you discover that specialized firms involved in similar projects have, on average, the following characteristics: (1) their capital structure is 15% debt and 85% common equity, (2) their cost of debt is typically 12%, and (3) they have a beta of 1.75. Given this information, what would your estimate be for the new division’s cost of capital? i. (1) Delta estimates that if it issues new common stock, the flotation cost will be 12.5%. Delta incorporates the flotation costs into the DCF approach. What is the estimated cost of newly issued common stock, taking into account the flotation cost? (2) Suppose Delta issues 30-year debt with a par value of $1,000 and a coupon rate of 10%, paid annually. If flotation costs are 3%, what is the after-tax cost of debt for the new bond issue?