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BL

BL (B)

7.2
0.9
1.1125

BL (c )
CoE

0.2325
8.86

BU

D/E
BL (B)

3
Bond value at t=3
D2
r-g
SP @ t=3
CV
FV

750
5.5125
0.16666667
36.4651875
729.30375
750

4 Equity
Debt
Assets
EBIT
Int
EBT
Tax @ 40%
PAT
ROA
ROE
EPS

1000
0
1000
150
0
150
60
90
0.09
0.09
4.5

700
300
1000
150
24
126
50.4
75.6
0.0756
0.108
3.78

0.72
1.25
0.25
0.416667
1.25
1.1125

15.9

0.9

Since the bond sells at par of $1,000, its YTM and coupon rate (12 percent) are equal. Thus, the before-tax cost o
rd,After-tax = 12.0%(1 - 0.40) = 7.2%.

Cost of preferred stock: rps = $12/$100(0.95) = 12.6%.

Cost of common stock (CAPM approach):


rs = 10% + (5%)1.2 = 16.0%.

Cost of common stock (DCF approach):


rs =
$2.00(1.08) + 8% = 16.0%.
$27

Cost of common stock (Bond yield-plus-risk-premium approach):


rs = 12.0% + 4.0% = 16.0%.

WACC = wdrd(1 - T) + wpsrps + wcers


= 0.2(12.0%)(0.6) + 0.2(12.6%) + 0.6(16.0%) = 13.56% 13.6%.

equal. Thus, the before-tax cost of debt to Rollins is 12 percent. The after-tax cost of debt equals:

Fee
Job loss
Placements

11.50%
0
-650000
0

1
-650000
-840000

5%
2
0
-882000

PV of existing job
TV of future job

-12923077

Total CFs
PVs
NPV

-13573077
-650000 80000000
-13573077 -582959.6 64348770
50192734

80000000

10%
4

1200000

1320000

Fee
Job loss
Placements

11.50%
0
-650000
0

1
-650000
-856000

7%
2
0
-915920

PV of existing job
TV of future job

-19022222

Total CFs
PVs
NPV

-19672222
-650000 26666667
-19672222 -582959.6 21449590
1194408.2

26666667

7%
4

1200000

1284000

Loan repayment
Job loss
Placements

11.50%
0

7%
2

-856000

-915920

PV of loan
PV of existing job
TV of future job

-1045668
-19022222

Total CFs
PVs
NPV

-20067890
-20067890
-405765.5

24444444
0 24444444
0 19662124

3
-149500

7%
4
-149500

1100000

1177000