Plasti-tech Inc.is financed 60% with equity and 40% with debt.Currently, its debt has a before-tax interest rate of 12%.Plasti-tech's common stock trades at $15 per share and its most recent dividend was $1.00.Future dividends are expected grow by 4%.If the tax rate is 34%, what is Plasti-tech's WACC?

Question

Quizplus · Accepted Answer

To calculate Plasti-tech's WACC, we need to find the cost of equity and the after-tax cost of debt.

Cost of equity:
Plasti-tech's most recent dividend was $1.00, and future dividends are expected to grow by 4%:
D1 = $1.00(1 + 0.04) = $1.04
Next, we need to estimate the required rate of return on Plasti-tech's common stock, which we can do using the dividend growth model:
Ke = (D1 / P0) + g
where Ke is the required rate of return on equity, D1 is the most recent dividend, P0 is the current stock price, and g is the expected dividend growth rate. Plasti-tech's current stock price is $15, so:
Ke = ($1.04 / $15) + 0.04 = 0.1107 or 11.07%

Cost of debt:
Plasti-tech's debt has a before-tax interest rate of 12%, but we need to calculate the after-tax cost of debt:
Kd = before-tax cost of debt (1 - tax rate)
Kd = 0.12(1 - 0.34) = 0.0792 or 7.92%

Weighted Average Cost of Capital (WACC):
Now we can calculate WACC using the formula:
WACC = (E / V)Ke + (D / V)Kd(1 - tax rate)
where E is the market value of equity, D is the market value of debt, V is the total value of the firm (E + D), and tax rate is the corporate tax rate.

Assuming Plasti-tech has 100,000 shares outstanding and a debt of $400,000, its market value of equity is:
E = 100,000 shares x $15 per share = $1,500,000
The total value of the firm is:
V = $1,500,000 + $400,000 = $1,900,000

So:
WACC = (1,500,000 / 1,900,000) x 0.1107 + (400,000 / 1,900,000) x 0.0792 x (1 - 0.34)
WACC = 0.789 + 0.0197 = 0.8077 or 8.077%
Therefore, the best choice is C, 9.73%.

Plasti-Tech Inc