Question

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 = $23.50. The last dividend was D₀ = $3.25, and it is expected to grow at a 8% 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

As per DDM

Price = recent dividend* (1 + growth rate )/(cost of equity - growth rate)

23.5 = 3.25 * (1+0.08) / (Cost of equity - 0.08)

Cost of equity% = 22.94

b

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 8*(1-0.4)

= 4.8

Weight of equity = 1-D/A

Weight of equity = 1-0.35

W(E)=0.65

Weight of debt = D/A

Weight of debt = 0.35

W(D)=0.35

WACC=after tax cost of debt*W(D)+cost of equity*W(E)

WACC=4.8*0.35+22.94*0.65

WACC% = 16.59