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 25%.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?

Question

Quizplus · Accepted Answer

First, we need to calculate the cost of equity using the constant growth rate formula:

Cost of Equity = (Dividend / Price) + Growth Rate
Cost of Equity = ($2.50 / $52.50) + 5.50%
Cost of Equity = 10.33%

Next, we calculate the after-tax cost of debt:

After-Tax Cost of Debt = (Before-Tax Cost of Debt) x (1 - Tax Rate)
After-Tax Cost of Debt = 7.50% x (1 - 0.25)
After-Tax Cost of Debt = 5.63%

Finally, we calculate the weighted average cost of capital (WACC):

WACC = (Weight of Debt x After-Tax Cost of Debt) + (Weight of Equity x Cost of Equity)
WACC = (0.45 x 5.63%) + (0.55 x 10.33%)
WACC = 8.18%

Therefore, the company's WACC if all equity used is from reinvested earnings is 8.18%, which is closest to option C (8.18%).

Quinlan Enterprises Stock Trades for $52