Quinlan Enterprises stock trades for $52.50 per shareIt 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 retained earnings?

Question

Quizplus · Accepted Answer

First, we need to calculate the cost of equity using the dividend growth model:
Ke = (D1 / P0) + g
Ke = ($2.50 / $52.50) + 5.50%
Ke = 10.09%

Next, we need to calculate the after-tax cost of debt:
Kd = before-tax cost of debt x (1 - tax rate)
Kd = 7.50% x (1 - 0.40)
Kd = 4.50%

Now, we can calculate the weighted average cost of capital (WACC):
WACC = (wD x Kd x (1 - tax rate)) + (wE x Ke)
WACC = (0.45 x 4.50% x (1 - 0.40)) + (0.55 x 10.09%)
WACC = 7.67%

Therefore, the best choice is C, with a WACC of 7.67%.

Quinlan Enterprises Stock Trades for $52