Answer:
cost of equity or r = 0.1610576923 or 16.10576923% rounded off to 16.11%
WACC = 0.1309375 or 13.09375% rounded off to 13.09%
Explanation:
The constant growth model of DDM is used to value stock paying a dividend which is growing at a constant rate. The formula for price today of such a stock is,
P0 = D0 * (1+g)/ r - g
Where,
- D0 is dividend today
- r is the required rate of return or cost of equity
- g is the constant growth rate
By plugging in the values of P0, D0 and g in the formula we can calculate r,
26 = 2.75 * (1+0.05) / (r - 0.05)
26 * (r - 0.05) = 2.8875
26r - 1.3 = 2.8875
26r = 2.8875 + 1.3
r = 4.1875 / 26
r = 0.1610576923 or 16.10576923% rounded off to 16.11%
Cost of common equity is 16.11%
The WACC or weighted average cost of capital is the cost of a firm's capital structure. The capital structure contains at least one of at most all of the following components namely debt, preferred stock and common equity.
The WACC for a company having only debt and common equity is calculated as follows,
WACC = wD * rD * (1 - tax rate) + wE * rE
Where,
- wD, wE represents the weight of debt and equity
- rD, rE represents the cost of debt and equity
- We take the after tax cost of debt so we multiply the cost of debt by (1 - tax rate)
WACC = 0.35 * 0.1 * (1 - 0.25) + 0.65 * 0.1610576923
WACC = 0.1309375 or 13.09375% rounded off to 13.09%
