Rollins Corporation is estimating its WACC. Its target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sell for $1,000. The firm could sell, at par, $100 preferred stock which pays a 12 percent annual dividend, but flotation costs of 5 percent would be incurred. Rollins' beta is 1.2, the risk-free rate is 10 percent, and the market risk premium is 5 percent. Rollins is a constant-growth firm which just paid a dividend of $2.00, sells for $27.00 per share, and has a growth rate of 8 percent. The firm's policy is to use a risk premium of 4 percentage points when using the bond-yield-plus-risk-premium method to find rs. The firm's marginal tax rate is 40 percent.
1. What is Rollins' component cost of debt?
2. What is Rollins' cost of preferred stock?
3. What is Rollins' cost of common stock (rs) using the CAPM approach?
4. What is the firm's cost of common stock (rs) using the DCF approach?
This is a standard question of WACC included in the chapter of Cost of Capital.
1. Cost of debt
0 1 2 3 4 40 6-month
The solution examines managerial finance for Rollins Corporation. The WACC is determined.