Question

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. r_s =   %
2. 
   
3. WACC =   %

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%