Assume that you are an intern with the Brayton Company, and you have collected the following data: The yield on the company's outstanding bonds is 7.75%; its tax rate is 25%; 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?
A) 7.34%
B) 7.73%
C) 8.14%
D) 8.56%
E) 8.99%

Question

Quizplus · Accepted Answer

To calculate the firm's Weighted Average Cost of Capital (WACC) when new stock must be issued, we first determine the cost of debt and the cost of equity, and then apply the target capital structure weights.1. **Cost of Debt (Rd)**: Given as 7.75%. Since interest is tax-deductible, we adjust this for taxes: $Rd = 7.75\% \times (1 - 0.25) = 5.8125\%$.2. **Cost of New Equity (Re)**: We use the Gordon Growth Model (Dividend Discount Model for a perpetually growing dividend) to calculate the cost of equity, adjusting for flotation costs. The model is $Re = (D1 / P0 \times (1-F)) + g$, where $D1$ is the next expected dividend, $P0$ is the current stock price, $F$ is the flotation cost as a decimal, and $g$ is the growth rate.   - $Re = (\$0.65 / (\$15 \times (1-0.10))) + 0.06 = (\$0.65 / \$13.5) + 0.06 = 0.04815 + 0.06 = 10.815\%$.3. **WACC Calculation**: With the target capital structure being 45% debt and 55% equity, we calculate WACC as follows:   - $WACC = (Wd \times Rd) + (We \times Re) = (0.45 \times 5.8125\%) + (0.55 \times 10.815\%) = 2.6156\% + 5.94825\% = 8.56385\%$.Rounding to two decimal places, the WACC is approximately 8.56%.

Assume That You Are an Intern with the Brayton Company