### Calculating cost of preferred stock

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1. Calculating Cost of Equity. Stock in CDB Industries has a beta of .90. The market risk premium is 7 percent, and T-bills are currently yielding 3.5 percent. CDB's most recent dividend was \$1.80 per share, and dividends are expected to grow at a 5 percent annual rate indefinitely. If the stock sells for \$47 per share, what is your best estimate of CDB's cost of equity?

2. Calculating Cost of Preferred Stock. Sixth Fourth Bank has an issue of preferred stock with a \$6.25 stated dividend that just sold for \$108 per share. What is the bank's cost of preferred stock?

3. Calculating Cost of Debt. ICU Window, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with seven years to maturity that is quoted at 108 percent of face value. The issue makes semiannual payments and has an embedded cost of 6.1 percent annually. What is ICU's pretax cost of debt? If the tax rate is 38 percent, what is the aftertax cost of debt?

4. Finding the WACC. Given the following information for Janicek Power Co., find the WACC. Assume the company's tax rate is 35 percent.

Debt: 8,500 7.2 percent coupon bonds outstanding, \$1,000 par value, 25 years to maturity, selling for 118 percent of par; the bonds make semiannual payments.

Common stock: 225,000 shares outstanding, selling for \$87 per share; beta is 1.15.

Preferred stock: 15,000 shares of 4.8 percent preferred stock outstanding, currently selling for \$98 per share.

Market: 7 percent market risk premium and 3.1 percent risk-free rate.

5. EBIT and Leverage. Kaelea, Inc., has no debt outstanding and a total market value of \$125,000. Earnings before interest and taxes, EBIT, are projected to be \$10,400 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 20 percent higher. If there is a recession, then EBIT will be 35 percent lower. Kaelea is considering a \$42,000 debt issue with a 6 percent interest rate. The proceeds will be used to repurchase shares of stock. There are currently 6,250 shares outstanding. Ignore taxes for this problem.

a. Calculate earnings per share, EPS, under each of the three economic scenarios before any debt is issued. Also, calculate the percentage changes in EPS when the economy expands or enters a recession.

b. Repeat part (a) assuming that Kaelea goes through with recapitalization. What do you observe?

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