Question

Palencia Paints Corporation has a target capital structure of 25% debt and 75% common equity, with no preferred stock. Its before-tax cost of debt is 11%, and its marginal tax rate is 40%. The current stock price is P0 = $29.00. The last dividend was D0 = $2.50, and it is expected to grow at an 8% constant rate. What is its cost of common equity and its WACC? Do not round intermediate calculations. Round your answers to two decimal places. rs = 17.31 % WACC = 14.61 %

Answer 1

Answer:

Ke 0.173103448

WACC 14.63250%

Explanation:

From the gordon model we determinate Ke

$\frac{divends}{return-growth} = Intrinsic \: Value$

$\frac{divends}{Price} = return-growth$

$\frac{divends}{Price} + growth = return$

D1 2.7 (we are given with D0 so we multiply by (1+g) to get D1

P 29

g 0.08

$Cost of Equity =\frac{2.7}{29} +0.08$

Ke 0.173103448

Now we use this value to determinate the WACC

$WACC = K_e(\frac{E}{E+D}) + K_d(1-t)(\frac{D}{E+D})$

Ke 0.1731

Equity weight 0.75

Kd 0.11

Debt Weight 0.25

t 0.4

$WACC = 0.1731(0.75) + 0.11(1-0.4)(0.25)$

WACC 14.63250%