Quinlan Enterprises stock trades for $52.50 per share. It is expected to pay a $2.50 dividend at year end (D1 = $2.50), and the dividend is expected to grow at a constant rate of 5.50% a year. 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 reinvested earnings? a. 7.07%b. 7.36%c. 7.67%d. 7.98%e. 8.29%

Question

Business

Sheldon Reese

23 March, 01:30

Quinlan Enterprises stock trades for $52.50 per share. It is expected to pay a $2.50 dividend at year end (D1 = $2.50), and the dividend is expected to grow at a constant rate of 5.50% a year. 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 reinvested earnings? a. 7.07%b. 7.36%c. 7.67%d. 7.98%e. 8.29%

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Jamarcus Chapman · Answer 1

c. 7.67%

Explanation:

The formula to compute WACC is shown below:

= Weightage of debt * cost of debt * (1 - tax rate) + (Weightage of common stock) * (cost of common stock)

where,

Cost of common equity equals to

= (Current year dividend : price per share) + growth rate

= ($2.50 : $52.50) + 5.50%

= 4.76% + 5.50%

= 10.26%

The other things would remain the same

Now put these values to the above formula

So, the value would equal to

= (0.45 * 7.5%) * (1 - 40%) + (0.55 * 10.26%)

= 2.025% + 5.643%

= 7.67%