Quinlan Enterprises stock trades for $52.50 per share. It is expected to pay a $2.50 dividend at year end (D1 = $2.50), and the dividend is expected to grow at a constant rate of 5.50% a year. 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 reinvested earnings?

Question

Quizplus · Accepted Answer

$\begin{array} { l r } 
\mathrm { D } _ { 1 } & \$ 2.50 \
\mathrm {~g} & 5.50 \% \
\mathrm { P } _ { \mathrm { 0 } } & \$ 52.50 \
\mathrm { r } _ { \mathrm { d } } & 7.50 \% \
\text { Tax rate } & 40 \% \
\mathrm { w } _ { \mathrm { d } } & 45 \% \
\mathrm { w } _ { s } & 55 \% \
\mathrm { r } _ { \mathrm { d } } ( 1 - \mathrm { T } ) & 4.50 \% \
\mathrm { r } _ { s } = \mathrm { D } _ { 1 } / \mathrm { P } _ { \mathrm { a } } + \mathrm { g } & 10.26 \% \
\mathrm { WACC } _ { \mathrm { d } } = \mathrm { w } _ { \mathrm { d } } \left( \mathrm { r } _ { \mathrm { d } } \right) ( 1 - \mathrm { T } ) + \mathrm { w } _ { s } \left( \mathrm { r } _ { \mathrm { f } } \right) = & 7.67 \%
\end{array}$

Quinlan Enterprises Stock Trades for $52