Question

Quinlan Enterprises stock trades for $52.50 per share. It is expected to pay a $2.50 dividend at year end (D1 = $2.50), and the dividend is expected to grow at a constant rate of 5.50% a year. The before-tax cost of debt is 7.50%, and the tax rate is 40%. The target capital structure consists of 45% debt and 55% common equity. What is the company's WACC if all the equity used is from reinvested earnings?a. 7.07%b. 7.36%c. 7.67%d. 7.98%e. 8.29%

Answer 1

Answer:

c. 7.67%

Explanation:

The formula to compute WACC is shown below:

= Weightage of debt × cost of debt × ( 1- tax rate) +  (Weightage of  common stock) × (cost of common stock)

where,  

Cost of common equity equals to

= (Current year dividend ÷ price per share) + growth rate

= ($2.50 ÷ $52.50) + 5.50%

= 4.76% + 5.50%

= 10.26%

The other things would remain the same

Now put these values to the above formula  

So, the value would equal to

= (0.45 × 7.5%) × ( 1 - 40%) +  (0.55 × 10.26%)

= 2.025% + 5.643%

= 7.67%