Question

Kuhn does not have any retained earnings available to finance this project, so the firm will have to issue new common stock to help fund it. Its common stock is currently selling for $22.35 per share, and it is expected to pay a dividend of $2.78 at the end of next year. Flotation costs will represent 8% of the funds raised by issuing new common stock. The company is projected to grow at a constant rate of 9.2%, and they face a tax rate of 25%. What will be the WACC for this project

Answer 1

Answer:

The WACC for this project is 22.72%.

Explanation:

P = common stock current selling price per share = $22.35

D1 = Expected dividend next year = $2.78

F = Floating cost = 8%, or 0.08

g = growth rate = 9.2%, or 0.092

t = tax rate = 0.25

r = Ke = cost of equity

The cost of equity can be calculated using the dividend grow model with the consideration of the effect of the issuance or floating cost that reduces cash collected as follows:

P(1 – F) = D1 / (r – g) ….................... (1)

Substituting the relevant value into equation (1) and solve r as follows:

22.35(1 – 0.08) = 2.78 / (r – 0.092)

22.35 * 0.92 = 2.78 / (r – 0.092)

20.562 = 2.78 / (r – 0.092)

20.562 (r – 0.092) = 2.78

20.562r - 1.891704 = 2.78

20.562r  = 2.78 + 1.891704

20.562r = 4.671704

r = 4.671704 / 20.562

r = 0.2272, or 22.72%

Since there is no information that shows there is a debt, this implies that WACC is equal to the cost of equity. Therefore, we have:

WACC = r = Ke = 22.72