Rollin Corporation

MBA 520 Module Eight Activity Worksheet

Prompt: After reviewing the data in the problem, respond to the problems below. Indicate the answer you believe is correct.

Rollins Corporation has a target capital structure consisting of 20% debt, 20% preferred stock, and 60% common equity.  Assume the firm has insufficient retained earnings to fund the equity portion of its capital budget. It has 20-year, 12% semiannual coupon bonds that sell at their par value of $1,000.  The firm could sell, at par, $100 preferred stock that pays a 12% annual dividend, but flotation costs of 5% would be incurred.  Rollins’ beta is 1.2, the risk-free rate is 10%, and the market risk premium is 5%. 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%.  The firm’s policy is to use a risk premium of 4% when using the bond-yield-plus-risk-premium method to find r_s.  Flotation costs on new common stock total 10%, and the firm’s marginal tax rate is 40%.

Cost of debt                                                                                                                                      

1. What is Rollins’ component cost of debt?

10. 0%
11. 1%
12. 6%
13. 0%
14. 2%

2. What is Rollins’ cost of preferred stock?

10. 0%
11. 0%
12. 0%
13. 6%
14. 2%

3. What is Rollins’ cost of retained earnings using the CAPM approach?

13. 6%
14. 1%
15. 0%
16. 6%
17. 9%

4. What is the firm’s cost of retained earnings using the DCF approach?

13. 6%
14. 1%
15. 0%

5. What is Rollins’ cost of retained earnings using the bond-yield-plus-risk-premium approach?

13. 6%
14. 1%
15. 0%
16. 6%
17. 9%

6. What is Rollins’ WACC, if the firm has insufficient retained earnings to fund the equity portion of its capital budget?

13. 6%
14. 1%
15. 0%
16. 6%
17. 9%