Question

5. Moorhead industries’ common stock is currently trading at $80 a share. The stock is expected to pay a dividend of $4/share at the end of the year and the dividend is expected to grow at a constant rate of 6% a year. What is the cost of common equity?

6. Moorhead industries’ has a target capital structure of 35 percent debt, 20 percent preferred stock, and 45 percent common equity. It has a before-tax cost of debt of 8%, and its marginal tax rate is 22%. Using this information and the value calculated in question #5 and a cost of preferred stock of 2.5%, calculate the WACC.

7. Johnson Farms before-tax cost of debt is 7% and its marginal tax rate is 32%. The current stock price is $70/share. The expected dividend is $3/share. The dividend is expected to grow at a constant rate of 8%. What will be the firm’s cost of common equity and its WACC when the firm’s target capital structure is 40% debt and 60% common equity?

Answer 1

5.

Cost of equity = (Expected dividend / Current Stock price) + Growth rate

= ($4 / $80) + 6%

= 5% + 6%

= 11%

Cost of equity is 11%.

6.

Aftertax cost of debt = 8% × (1 - 22%)

= 6.24%

After tax cost of debt is 6.24%

Cost of preferred stock = 2.50%

WACC is calculated below:

WACC = (35% × 6.24%) + (20% × 2.50%) + (45% × 11%)

= 2.184% + 0.50% + 4.95%

= 7.634%

WACC of company is 7.634%.

7.

Cost of equity = (Expected dividend / Current Stock price) + Growth rate

= ($3 / $70) + 8%

= 4.29% + 8%

= 12.29%

Cost of equity is 12.29%.

Aftertax cost of debt = 7% × (1 - 32%)

= 4.76%

After tax cost of debt is 4.76%

WACC is calculated below:

WACC = (40% × 4.76%) + (60% × 12.29%)

= 1.904% + 7.37%

= 9.28%

WACC of company is 9.28%.