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 $15.00 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?

Question

Quizplus · Accepted Answer

1. Calculate cost of debt:
KD = Yield to maturity x (1 - Tax rate)
KD = 7.75% x (1 - 0.40)
KD = 4.65%

2. Calculate cost of equity:
KE = (Next year's dividend / Current stock price) + Expected growth rate
KE = ($0.65 / $15.00) + 6.00%
KE = 10.33%

3. Calculate WACC:
WACC = (Weight of debt x Cost of debt) + (Weight of equity x Cost of equity)
WACC = (0.45 x 4.65%) + (0.55 x 10.33%)
WACC = 7.64%

4. Adjust WACC for flotation cost:
WACCadjusted = WACC x (1 - Flotation cost)
WACCadjusted = 7.64% x (1 - 0.10) = 6.89%

Therefore, the best choice is D, 8.04%.

Assume That You Are on the Financial Staff of Vanderheiden