Question

Assume that you are an intern with the Brayton Company, and you have collected the following data: The yield on the company's outstanding bonds is 8.25%; its tax rate is 25%; the next expected dividend is $0.75 a share; the dividend is expected to grow at a constant rate of 5.00% a year; the price of the stock is $14.00 per share; the flotation cost for selling new shares is F = 5%; and the target capital structure is 40% debt and 60% common equity. What is the firm's WACC, assuming it must issue new stock to finance its capital budget?

Answer 1

Answer

Given that weights of Debt = 40% and equity = 60%

Also given

Yield on O/s Bonds = 8.25%

Tax Rate = 25%

Now, Therefore Post tax Cost of Debt = Yield on Bonds (1- Tax)

= 8.25(1-0.25)

=6.1875 %

Now we have

Expected Divided (D1) = $ 0.75

Current Price of the share (P) = $14

Growth Rate (G) = 5%

Floatation Cost (F) = 5%

We can compute the cost of equity = {D1/[P*(1-F)]}+G

Therefore Cost of Equity = [0.75/14(1-0.05)]+ 0.05

=10.6391 %

Now Given the weights we can compute the wacc using the below formula

WACC = Weight of Debt * Post Tax Cost of Debt + Weight Of Equity * Cost of Equity

WACC = 40% *6.1875 +60% *10.6391

WACC = 2.475+6.383

WACC = 8.86 %