Question

The Peterson company uses the dividend discount model to estimate the cost of retained earnings. If its stock is $19  and next year’s dividends is expected to be $1.36 and then growing at a constant rate 5% thereafter, what is, in percent, Peterson’s cost of retained earnings?

Garcia Inc. with 10 million preferred stock, 60 million equity, and 30 million debt, and with 6.5% cost of preferred stock, 9.1% cost of equity, and 4.5% before-tax cost of debt with a tax rate of 40% tax rate, what is Garcia’s WACC?  

Answer 1

1) Cost of retained earnings = (D1 / P0) + g

Cost of retained earnings = ($1.36 / $19) + 0.05

Cost of retained earnings = 0.1216 or 12.16%

2) Total value = 10 million + 60 million + 30 million = 100 million

WACC = (Weight of common stock * Cost of common equity) + (Weight of preferred stock * Cost of preferred stock) + [Weight of debt * Pretax cost of debt(1 - Tax)]

WACC = [(60 million/100 million) * 0.091) + [(10 million/100 million) * 0.065] + [(30 million/100 million) * 0.045(1 - 0.40)]

WACC = 0.0692 or 6.92%