Question

A firm maintains a debt-to-equity ratio of 0.55 and has a tax rate of 36%. The company does not issue preferred stock but has a pre-tax cost of debt of 8.75%. There are 20,000 shares of the company's stock outstanding with a beta of 0.9 and market price of $37.80. Yesterday, the company issued an annual dividend in the amount of $1.15 per share. Dividends are expected to grow at 4.74% indefinitely. What is the company's weighted average cost of capital?

Answer 1

After tax Cost of Debt = Pretax Cost of Debt * (1-tax rate)
After tax Cost of Debt = 8.75% *(1-0.36)
After tax Cost of Debt = 5.6%

D1 = D0 * (1 + g)
D1 = $1.15 * (1 + 0.0474)
D1 = $1.20

Cost of Common Equity = D1 / P0 + g
Cost of Common Equity = $1.20 / $37.80 + 0.0474
Cost of Common Equity = 0.0791 or 7.91%

Weight of Debt = 0.55/1.55
Weight of Debt = 0.3548

Weight of Common Stock = 1/1.55
Weight of Common Stock = 0.6452

WACC = Weight of Debt*After-tax Cost of Debt + Weight of Common Stock*Cost of Common Stock
WACC = 0.3548 * 5.6% + 0.6452 * 7.91%
WACC = 7.09%