Question

Palencia Paints Corporation has a target capital structure of 25% debt and 75% common equity, with...

Palencia Paints Corporation has a target capital structure of 25% debt and 75% common equity, with no preferred stock. Its before-tax cost of debt is 10%, and its marginal tax rate is 40%. The current stock price is P0 = $35.00. The last dividend was D0 = $3.00, and it is expected to grow at a 5% constant rate. What is its cost of common equity and its WACC? Do not round intermediate calculations. Round your answers to two decimal places.

  1. rs =   %

  2. WACC =   %

Homework Answers

Answer #1

Cost of common equity = dividend of next period/Price of stock + growth rate

Growth rate = 5%

Dividend of next period = dividend paid(1+growth rate)

=3(1+5%)

=3(1.05)

=3.15 $

Price of stock = 35$

Thus cost of common equity = 3.15/35 + 5%

= 0.09+0.05

=0.14

i.e 14%

Now lets calculate after tax cost of debt

after tax cost of debt = before tax cost of debt(1-tax rate)

= 10%(1-40%)

= 10% (0.6)

= 6%

Statement showing WACC

Source of capital Weight Cost of capital WACC
A B C= A x B
Equity 75% 14% 10.50%
Debt 35% 6% 2.10%
WACC = 12.60%

Thus WACC = 12.60%

Ans) Cost of equuity = 14.00%

WACC = 12.60%

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