Question

1. Biogenetics Corporation has a target capital structure of 60 % common stock, and the rest on bonds. The risk free rate is 5%, and the return on the stock market is 15%. This year, Biogenetics bonds had an YTM of 5.5%, and the company is on the 35 percent tax bracket. On last trading day, Biogenetics paid dividends of $3/share , which will grow at 3% every year. Last trading day the stock was selling at $30. The company beta is 1.5.

What is Biogenetics WACC? Show Calculation (10 points)

Answer 1

Weight of common stock = 0.6

Weight of bond = 1 - 0.6 = 0.4

Pre tax cost of debt = 5.5%

After tax cost of debt = 0.055 ( 1 - 0.35)

After tax cost of debt = 0.03575 or 3.575%

Cost of equity usind dividend discount model = (D1 / Share price) + g

Cost of equity = [3 ( 1 + 0.03) / 30] + 0.03

Cost of equity =0.103 + 0.03

Cost of equity = 13.3%

WACC = weight of equity * cost of equity + weight of debt * cost of debt

WACC = 0.6 * 0.133 + 0.4 * 0.03575

WACC = 0.0798 + 0.0143

WACC = 0.0947 or 9.41%