Crab Cakes Ltd. has 5 million shares of stock outstanding selling at $15 per share and an issue of $10 million in 10 percent, annual coupon bonds with a maturity of 25 years, selling at 97 percent of par ($1,000). If Crab Cakes' weighted average tax rate is 30 percent, its next dividend is expected to be $1.00 per share, and all future dividends are expected to grow at 5 percent per year, indefinitely, what is its WACC?
A)8.42 percent
B)10.84 percent
C)11.16 percent
D)11.52 percent

Question

Quizplus · Accepted Answer

First, we need to calculate the cost of equity using the dividend growth model:
Cost of Equity = (Next Dividend / Current Stock Price) + Dividend Growth Rate
Cost of Equity = ($1.00 / $15) + 0.05 = 0.12 or 12%
Next, we need to calculate the cost of debt:
Cost of Debt = (Annual Coupon Payment × (1 - Tax Rate)) / Net Proceeds
Cost of Debt = ($1,000 × 0.10 × (1 - 0.30)) / $970 = 0.084 or 8.4%
Next, we need to calculate the weights of equity and debt in the company's capital structure:
Weight of Equity = Market Value of Equity / Total Market Value
Weight of Equity = ($15 × 5,000,000) / (($15 × 5,000,000) + $9,700,000) = 0.345 or 34.5%
Weight of Debt = Market Value of Debt / Total Market Value
Weight of Debt = ($9,700,000) / (($15 × 5,000,000) + $9,700,000) = 0.655 or 65.5%
Finally, we can calculate the WACC:
WACC = (Weight of Equity × Cost of Equity) + (Weight of Debt × Cost of Debt)
WACC = (0.345 × 0.12) + (0.655 × 0.084) = 0.1116 or 11.16%