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 9% and its marginal tax rate is 40%. The current stock price is P0 = $28.50. The last dividend was D0 = $2.75, and it is expected to grow at a 6% 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.

rs = %

WACC = %

Answer 1

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

Cost of equity

As per DDM

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

28.5 = 2.75 * (1+0.06) / (Cost of equity - 0.06)

Cost of equity% = 16.23

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

After tax cost of debt = 9*(1-0.4)

= 5.4

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

WACC=5.4*0.35+16.23*0.65

WACC =12.44%