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Howard wants to start his own hotel company
Howard wants to start his own hotel company. He wants to finance the company using debt, preferred stocks, and common stocks. He has decided to set up his capital structure with 35% debt, 20% preferred stocks, and 45% common stocks. Market statistics: the risk-free ?ate is 3% and the market rate is 12%.
1. Suppose a bond pays $120 at the end of each year forever. If 12% is the relevant interest r4e, what is the value of this investment to you today?
Bond Price=
2. Howard wants to sell preferred stocks on the NYSE. His expected dividend is $4.00, and the required rate of return on the stock is 8%. At what price should Howard sell his preferred stock?
Preferred stock price =
3. Howard also wants to issue common stocks with a beta of 1.7. His projected dividend is $4.32, and the growth rate of his company is projected at 14%. At what price should he sell his stocks?
Rs (required rate of return) =
Common stock price =
Expert Solution
1) Computation of Bond Price:
Bond Price = Annual Perpetuity / Interest Rate
= $120/12%
Bond Price = $1,000
2) Computation of Preferred Stock Price:
Preferred Stock Price = Annual Dividend/Required Rate of Return
= $4/8%
Preferred Stock Price = $50
3) Computation of Required Rate of Return using CAPM:
Required Rate of Return = Risk-free Rate + Beta*Market Risk Premium
= 3% + 1.7*(12%-3%)
= 3% + 15.30%
Required Rate of Return = 18.30%
Computation of Common Stock Price:
Common Stock Price = Expected Dividend / (Required Rate of Return - Growth Rate)
= $4.32/(18.30%-14%)
= $4.32/4.30%
Common Stock Price = $100.47
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