Question

Assume that you are on the financial staff of Vanderheiden Inc., and you have collected the following data: The yield on the company’s outstanding bonds is 7.75%, its tax rate is 40%, the next expected dividend is $0.65 a share, the dividend is expected to grow at a constant rate of 6.00% a year, the price of the stock is $15.00 per share, the flotation cost for selling new shares is F = 10%, and the target capital structure is 45% debt and 55% common equity.

A) What is the firm's WACC, assuming it must issue new stock to finance its capital budget?

B) Based in the waccabtain in part (a) which project//, if any, should be selected. Explain what is your decision?

C) Based on your selection in part (b) what is the capital budget for the next planing period?

Answer 1

	D1	Next expected dividend	$0.65
	g	Dividend growth rate=6%=	0.06
	P0	Current Stock Price per share	$15
		Required return from Equity=R
		P0=D1/(R-g)
		R=(D1/P0)+g
		Required return	0.103333	(0.65/15)+0.06
		Required return	10.33%
		Floatation cost=10%	0.10
	Ce	Cost of Equity=10.33/(1-0.1)	11.48%
	Cd	Cost of Debt=7.75*(1-0.4)=	4.65%
	We	Weight of Equity	0.55
	Wd	Weight of Debt	0.45
	A)	WACC=(We*Ce)+(Wd*Cd)
		WACC=(0.55*11.48)+(0.45*4.65)=	8.4065	percent
		WACC=8.41%
		For B andC data regarding Projects are required