The Pluto Corporation has a capital structure consisting of 60 percent debt and 40 percent common equity. The financial managers of Pluto believe that these capital proportions represent the company's target capital structure. It Pluto was to issue new debt, it expects this debt will yield 10 percent. Currently, Pluto's stock is trading at $10 per shares, the current dividend is $0.10 per share, and Pluto's financial managers believe that this dividend will grow at a rate of 10 percent per year. If Pluto's marginal tax rate is 35 percent, Pluto's weighted average cost of capital is closest to:

Question

Quizplus · Accepted Answer

To calculate the weighted average cost of capital (WACC), we use the formula: WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc), where E is the market value of equity, D is the market value of debt, V is the total market value of the firm's financing (E + D), Re is the cost of equity, Rd is the cost of debt, and Tc is the corporate tax rate.Given:- Debt (D) = 60% of the capital structure- Equity (E) = 40% of the capital structure- Rd (cost of debt) = 10%- Tax rate (Tc) = 35%- Dividend (D0) = $0.10- Growth rate (g) = 10%- Stock price (P0) = $10First, calculate the cost of equity (Re) using the dividend discount model (Gordon Growth Model): Re = (D0 * (1 + g) / P0) + g = ($0.10 * (1 + 0.10) / $10) + 0.10 = 0.11 or 11%.Then, calculate WACC: WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc) = (0.40 * 11%) + (0.60 * 10%) * (1 - 0.35) = 4.4% + 3.9% = 8.3%.Therefore, the closest answer is 8.340%.

The Pluto Corporation Has a Capital Structure Consisting of 60