Question

Sorensen Systems Inc. is expected to pay a $2.50 dividend at year end (D1 = $2.50), the dividend is expected to grow at a constant rate of 5.50% a year, and the common stock currently sells for $52.50 a share. 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 retained earnings?

Answer 1

Answer:

WACC 7.69%

Explanation:

stock price=D1/(Ke-g)

Where Stock price=$52.5

D1=$2.5

Ke=?

g=5.5%

By putting above values in formula we get;

52.5=2.5/(Ke-5.5%)

52.5Ke-52.5*5.5%=2.5

52.5Ke=2.5+2.89

Ke=5.39/52.5

Ke=10.3%

Kd=7.5%

WACC=Ke*E+Kd*D/E+D

WACC=10.3%*55+7.5%*45*.6/100

WACC=7.69%

WACC=10.3(1-(45*.6/100))

WACC=10.3*.997