8. (20 pts) The stock of Gao Computing sells for $100. The management believes that their stock is undervalued in the market and should actually be around $150. A flotation cost of 15% would be required to issue new common stock. Gao’s preferred stock pays a dividend of $6 per share with $100 par value, and new preferred could be sold at $60 per share, but would incur a flotation cost of 5%. The firm’s long-term bonds are selling below par at $900, with a coupon rate of 5% paid semiannually and a 15-year maturity left on the bonds. The marginal tax rate of the firm is 35%. Security analysts are projecting that firm’s ROE will remain at 20%, and the firm is expected to earn $10.00 per share this year and to pay a year-end dividend of $3.60. The expected market return is 10%, the risk-free rate is 5%, and Gao’s beta is 1.5. Gao’s current capital structure is 45% debt, 5% preferred stock, and 50% equity, but their target capital structure going forward is with 35% debt, 10% preferred stock, and 55% common equity. Assume that Gao will have to issue new equity in calculating WACC. a. (5pts) What is Gao’s after tax cost of debt? b. (5pts ) What is Gao’s cost of preferred stock? c. (5pts) What is Gao’s cost of new common equity under dividend growth model? d. (5pts) What is Gao’s WACC based on the answers above?
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