Question

# Assume that you are on the financial staff of Vanderheiden Inc., and you have collected the...

Assume that you are on the financial staff of Vanderheiden Inc., and you have collected the following data: The yield on the company’s outstanding bonds is 7.75%, its tax rate is 25%, the next expected dividend is \$0.65 a share, the dividend is expected to grow at a constant rate of 6.00% a year, the price of the stock is \$14.00 per share, the flotation cost for selling new shares is F = 10%, and the target capital structure is 45% debt and 55% common equity. What is the firm's WACC, assuming it must issue new stock to finance its capital budget?

9.51%

7.98%

10.12%

8.75%

Expected Dividend (D1) = \$0.65

Floatation Cost = 10%

Growth Rate = 6%

Stock Price (P)= \$14

Now, Cost of Equity = [D1/P*(1-Floatation Cost)]+ Growth Rate

Cost of Equity = [0.65/14(0.90)] + 6%

Cost of Equity = 11.159%

Given the Pre Tax Cost of Debt = 7.75 %

Tax Rate = 25%

Post Tax Cost of Debt = Pre Tax Cost x (1-Tax Rate)

Post Tax Cost of Debt = 7.75%(1-0.25) = 5.8125%

Given the Target Capital Structure with weightage of Debt and equity of 45% and 55% respectively

Now WACC = Weight of Debt x Post Tax Cost of Debt + Weight of Equity x Cost of Equity

WACC = 0.45*5.8125% + 0.55*11.159%

WACC = 8.75%