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 $37.50 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? do not round your intermediate calculations.

Answer 1

Answer:

the company's wacc is 8.72 %

Explanation:

Weighted Average Cost of Capital (WACC) is the minimum return that a project must offer before it can be accepted.

WACC Calculation are as follows :

Capital Source                 Weight                Cost                 Total

Common stock                    55%       12.1666666 %           6.69166 %

Debt                                     45%             4.50 %                 2.025%

Total                                   100%                                          8.72 %

Cost of Common Equity is Calculated as follows :

The data available allows us to use the Dividend Growth Model to calculated the cost of common equity.

Cost of Common Equity = (Next year`s Dividend/Current Market Price of a share) + Expected growth rate.

                                        = ( $2.50/ $37.50) + 5.50%

                                        = 12.1666666 %

Cost of Debt is Calculated as follows :

Cost of Debt = Interest × ( 1 - tax rate)

                     = 7.50% × ( 1 - 0.40)

                     = 4.50 %