Question

8.

COST OF COMMON EQUITY AND WACC

Palencia Paints Corporation has a target capital structure of 35% debt and 65% common equity, with no preferred stock. Its before-tax cost of debt is 8%, and its marginal tax rate is 40%. The current stock price is P₀ = $22.50. The last dividend was D₀ = $2.25, and it is expected to grow at a 4% constant rate. What is its cost of common equity and its WACC? Round your answers to two decimal places. Do not round your intermediate calculations.

1. r_s =  %
2. 
   
3. WACC =  %

Answer 1

a). Current Stock price(P0) = $22.50

Last Dividend paid(D0) = $2.25

Growth rate(g) = 4%

Calculating the Cost of Equity(rs):-

rs = 14.4%

So, Cost of Equity(rs) is 14.4%

b). After-tax Cost of Debt = before-tax cost of Debt*(1- Tax rate)

After-tax Cost of Debt = 8%*(1-0.40)

After-tax Cost of Debt = 4.8%

c). Calculating WACC:-

WACC= (Weight of Debt)(Cost of Debt) + (Weight of Equity)(Cost of Equity)

WACC = (0.35)(4.8%) + (0.65)(14.4%)

WACC = 1.68% + 9.36

WACC = 11.04%

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