Sorensen Systems Inc.is expected to pay a $2.50 dividend at year end (D₁ = $2.50),the dividend is expected to grow at a constant rate of 5.50% a year,and the common stock currently sells for $52.50 a share.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?

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Quizplus · Accepted Answer

The WACC is calculated using the formula: WACC = (E/V) * Re + (D/V) * Rd * (1-Tc). Here, Re (cost of equity) is calculated using the Gordon Growth Model: Re = (D1/P0) + g = ($2.50/$52.50) + 5.50% = 10.26%. The after-tax cost of debt is Rd * (1-Tc) = 7.50% * (1-0.40) = 4.50%. Thus, WACC = 0.55 * 10.26% + 0.45 * 4.50% = 7.67%.