Schadler Systems is expected to pay a $3.50 dividend at year end (D₁ = $3.50),the dividend is expected to grow at a constant rate of 6.50% a year,and the common stock currently sells for $62.50 a share.The before-tax cost of debt is 7.50%,and the tax rate is 40%.The target capital structure consists of 40% debt and 60% common equity.What is the company's WACC if all equity is from retained earnings?

Question

Quizplus · Accepted Answer

The WACC is calculated using the formula: WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc). Here, Re is the cost of equity, Rd is the cost of debt, 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 (equity + debt), and Tc is the tax rate. The cost of equity (Re) can be calculated using the Gordon Growth Model: Re = (D1/P0) + g = ($3.50/$62.50) + 0.065 = 0.121 or 12.1%. The WACC is then: WACC = (0.60 * 0.121) + (0.40 * 0.075 * (1 - 0.40)) = 0.0906 or 9.06%.

Schadler Systems Is Expected to Pay a $3