Question

Assume that you are on the financial staff of Vanderheiden Inc., and you have collected the following data: The yield on the company's outstanding bonds is 7.75%, its tax rate is 40%, the next expected dividend is $0.65 a share, the dividend is expected to grow at a constant rate of 6.00% a year, the price of the stock is $17.00 per share, the flotation cost for selling new shares is F = 10%, and the target capital structure is 45% debt and 55% common equity. What is the firm's WACC, assuming it must issue new stock to finance its capital budget? a. 9.51% b. 7.73% c. 5.80% d. 6.65% e. 6.18%

Answer 1

Answer:

Ke = D1/Po(1-F) + g

Ke = $0.65/17(1-0.1) + 0.06

Ke = 0.0425 + 0.06

ke = 0.1025 = 10.25%

WACC = Ke(E/V) + Kd(D/V)(1-T)

WACC = 10.25(55/100) + 7.75(45/100)(1-0.4)

WACC = 5.6375 + 2.0925

WACC = 7.73%

Explanation:

In this case, there is need to calculate cost of equity in the light of floatation cost using the above formula. Thus, we will now calculate WACC by considering cost of equity and the proportion of equity in the capital structure plus after-tax cost of debt and the proportion of debt in the capital structure.