PART 1:

Adam has been asked to calculate the weighted average cost of capital (WACC) for an important client (TLC Inc.) of the company.

TLC has a Debt-to-Equity Ratio of 50%, and a tax rate of 40%. TLC has 20-year bonds that have been issued 7 years ago. The bonds were originally issued with a 9% Coupon Rate and are presently selling for 108% of face value.

TLC Inc. has a Beta of 0.90 and many people in the investment community are projecting a Market Risk premium of only 7%. The Risk-free rate of interest is presently yielding 8%.

TLC Inc. had just issued a dividend of $1.80 per share and guidance has been provided to the markets that the dividend is expected to grow at 7% for the foreseeable future. After checking the market watch website, we see that share of TLC is trading at $25 per share.

The boss also asks to explain in a paragraph why using WACC is not always appropriate in evaluating projects.

PART 2:

1. What would the price of (TLC Inc.) stock be if the company paid out dividends of $126,000, has an Outstanding float of 100,000 common shares, has a Return on Equity of 25%, and Earnings per share of $4.54?
2. The boss wants you to use the Dividend growth model to calculate the price of (TLC Inc.) stock as well as list the advantages and disadvantages of this model.

Answer:

Part 1:

WACC of TLC Inc.: 12.65%

WACC is not appropriate as it does not consider the variation in risk of the projects in the future and variation in the cap. (Capital) Structure in the future project period. WACC takes the assumption that risk & Cap. structure of the Project will remain intact in the entire project life.

Part 2:

1. Price of TLC Inc. stock: $17.26

2. The price of the TLC Inc. as per DGM(Dividend Growth Model): $18.47

Advantages: simple to interpret, simple to make comparisons or analyzing with various companies.

Disadvantages: It avoids considering non-financial factors, with these market Brand image & not feasible to compute share price(SP) if growth rate exceeds Cost of Equity(COE).

Step-by-step explanation

Part 1:

Computation of WACC of TLC Inc.:

The WACC of TLC Inc., using market values, is 12.65%.

The problem with using WACC is it can only be feasible for evaluating projects which are static throughout the project period. If the project is dynamic, say the risk of the projects varies frequently or the structure of capital mix varies during the project life then WACC is not feasible for evaluating Project decisions.

Part 2:

1. Computation of Stock Price(SP) of TLC Inc:

The market price(MP) of TLC Inc. is $17.26, which is derived by using the growth rate given in part 1 of the question.

2. 

Computation of price of TLC Inc. using Dividend Growth(Gordon's Growth) Model:

The price of TLC Inc.'s share as per the Dividend Growth(Gordon's Growth) Model is $18.47, computed using the growth rate mentioned in part 1 of the question.

Advantages/Pros of Gordon's Dividend Growth method:

• It is the most simple way of computing the price of the stock.
• It doesn't consider the market implications on Share Price(SP). It only needs growth(g), Dividend for subsequent period(D1) & Cost of Equity(COE)

 Disadvantages/Cons of Gordon's Dividend Growth method:

• This model is unable to compute the SP if growth exceeds COE (g > COE).
• It does not consider the impact of non-financial factors like Brand Value. It also depends highly on dividend growth, which is unpredictable in the real world. 

Reference:

PE ratio:

https://corporatefinanceinstitute.com/resources/knowledge/valuation/price-earnings-ratio/

WACC:

https://www.investopedia.com/terms/w/wacc.asp

Pros & Cons of Gordon's Growth Model:

https://www.investopedia.com/ask/answers/032415/what-are-advantages-and-disadvantages-gordon-growth-model.asp

Pros & Cons of WACC:

https://efinancemanagement.com/investment-decisions/evaluating-new-projects-with-weighted-average-cost-of-capital-wacc

please use this google drive link to download the answer file.

https://drive.google.com/file/d/1maoIJTi92OecM72e2MHXfD5Ig6ytlBnU/view?usp=sharing

note: if you have any trouble in viewing/downloading the answer from the given link, please use this below guide to understand the whole process.

https://helpinhomework.org/blog/how-to-obtain-answer-through-google-drive-link