Listed below is the condensed 2013 balance sheet for the Skye Computer
Company (in thousands of dollars):
Net fixed assets
Total liabilities and equity
Skye’s common stock sells for $55.00, last year’s dividend was $2.10, and a
flotation cost of 10% would be required to sell new common stock. Security
analysts are projecting that the common dividend will grow at a rate 9% per year.
Skye’s preferred stock pays a dividend of $3.30 per share, and new preferred
stock could be sold at a price to net the company $30.00 per share. The firm
can issue long-term debt at a before-tax cost of 10%, and its tax rate is 35%.
The market rate is 15%, the risk-free rate is 6% and Skye’s beta is 1.516.
Calculate the cost of each capital component, that is, the after-tax cost of debt,
the cost of preferred stock and the cost of common equity. Use the Constant Dividend
Growth Model to find the cost of common equity.
Now calculate the cost of common equity from retained earnings using, as
defined in your textbook, as the Security Market Line Approach.
Now calculate the cost of new common stock.
If Skye continues to use the same capital structure, what is Skye’s WACC
(weighted-average cost of capital) in Part A? What is the WACC using the information
from Part B? What is the WACC using the information from Part C?