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Rollins Corporation
Rollins Corporation
stock, and 60 percent common equity. Assume the firm has insufficient retained earnings to fund the equity
portion of its capital budget. 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 that 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 that 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 k s. Flotation costs on new common stock
total 10 percent, and the firm's marginal tax rate is 40 percent.
What is Rollins' component cost of debt?
(i) What is Rollins' cost of preferred stock?
(ii) What is Rollins' cost of retained earnings using the CAPM approach?
(iii) What is the firm's cost of retained earnings using the DCF approach?
(iv) What is Rollins' cost of retained earnings using the bond-yield-plus-risk-premium approach?
(v) What is Rollins' WACC, if the firm has insufficient retained earnings to fund the equity portion of its
capital budget?
Answer:
Kd=[Int+(M-Nd)/n]/[(Nd+M)/2]
= [60+(1000-1000)/40]/[(1000+1000)/2]
= 0.12(1-0.40)
= 0.072
Kp=Div1/(Po-Fc)
= (100*0.12)/(100-5)
= 0.1263
= 12.63%
Ke= Rf+B((RM-RF)
= 0.10+ 1.2*0.05
= 0.16
Ke= (Div1/Po)+g
= ((2*1.08)/27)+0.08
= 0.16
= 0.12+ 0.04
= 0.16
WACC= (WD*Kd)+(Wp*Kp)+(We*Ke)
= 0.1357
= 13.57%