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# Current Stock Price and Cost of Equity from Retain

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16. The Connors Company's last dividend was \$1.00. Its dividend growth rate is expected to be constant at 15% for 2 years, after which dividends are expected to grow at a rate of 10% forever. Connors' required return (rs) is 12%. What is Connors' current stock price?
\$54.91
\$56.82
\$58.15
\$60.07
\$62.87

17. Assume that Mary Brown Inc. hired you as a consultant to help it estimate the cost of capital. You have been provided with the following data: D0 = \$1.20; P0 = \$40.00; and g = 7% (constant). Based on the DCF approach, what is Brown's cost of equity from retained earnings?
10.06%
10.21%
10.37%
10.54%
10.68%

18. You were hired as a consultant to Locke Company, and you were provided with the following data: Target capital structure: 40% debt, 10% preferred, and 50% common equity. The interest rate on new debt is 7.5%, the yield on the preferred is 7.0%, the cost of retained earnings is 11.50%, and the tax rate is 40%. The firm will not be issuing any new stock. What is the firm's WACC?
8.25%
8.38%
8.49%
8.61%
8.76%

19. Safeco Company and Risco Inc are identical in size and capital structure. However, the riskiness of their assets and cash flows are somewhat different, resulting in Safeco having a WACC of 10% and Risco a 12% WACC. Safeco is considering Project X, which has an IRR of 10.5% and is of the same risk as a typical Safeco project. Risco is considering Project Y, which has an IRR of 11.5% and is of the same risk as a typical Risco project.
Now assume that the two companies merge and form a new company, Safeco/Risco Inc. Moreover, the new company's market risk is an average of the pre-merger companies' market risks, and the merger has no impact on either the cash flows or the risks of projects X and Y. Which of the following statements is CORRECT?

Safeco/Risco's WACC, as a result of the merger, would be 10%.
If evaluated using the correct post-merger WACC, Project X would have a negative NPV.
After the merger, Safeco/Risco would have a corporate WACC of 11%. Therefore, it should reject Project X but accept Project Y.
If the firm evaluates these projects and all other projects at the new overall corporate WACC, it will become riskier over time.
After the merger, Safeco/Risco should select Project Y but reject Project X.

20. Blanchford Enterprises is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's projected IRR can be less than the WACC (and even negative), in which case it will be rejected.
Year: 0 1 2 3
Cash flows: -\$1,000 \$450 \$450 \$450

16.20%
16.65%
17.10%
17.55%
18.00%

#### Solution Preview

16. The Connors Company's last dividend was \$1.00. Its dividend growth rate is expected to be constant at 15% for 2 years, after which dividends are expected to grow at a rate of 10% forever. Connors' required return (rs) is 12%. What is Connors' current stock price?
\$60.07

You have to find the dividend to be paid each year by multiplying the growth rate of 15% for the first two years and 10% for the next year.
D0 = \$1.00
D1 = 1.00(1.15) = 1.15
D2 = 1.15(1.15) = 1.3225
D3 = 1.3225(1.10) = 1.4548
Then, you can find the price of the stock at the end of year 2 as follows: -
P = D3 where D3 is the dividend for year 3
(rs - g) rs is the required rate of return
g is the growth rate
P is the current price
P = 1.4548
(0.12 - 0.10)

P = 72.7375
You would need to find the total present value of all dividend paid and the price at the end of year 2 by discounting by its require rate of return.
D1 ...

#### Solution Summary

This solution is comprised of a detailed explanation to answer what is Connors' current stock price.

\$2.19