Question

Porta Potty Corporation has a target capital structure of 60% debt and 40% common equity, with no preferred stock. Its before-tax cost of debt is 12%, and its marginal tax rate is 40%. The current stock price is P = $22.50. The last dividend was D0 = $2.00, and it is expected to grow at a 7% constant rate. What is its WACC?

Answer 1

Given about Porta Potty Corporation,

Target Capital structure is

weight of debt Wd = 60%

Weight of equity We = 40%

Cost of Debt Kd = 12%

Marginal tax rate T = 40%

Current stock price P0 = $22.50

Last dividend D0 = $2

expected growth rate rate g = 7%

So using constant dividend growth rate model, cost of equity Ke is

Ke = D0*(1+g)/P0 + g

=> Ke = 2*1.07/22.50 + 0.07 = 16.51%

So, cost of equity Ke = 16.51%

So, WACC of the company is Wd*Kd*(1-T) + We*Ke

=> WACC = 0.6*12*(1-0.40) + 0.4*16.51 = 10.92%