Question

2. Calculate the weighted average cost of capital for a company given the following information:

Price of the company’s common stock: $30.04

Dividend just been paid: $2.6

Expected perpetual constant growth rate: 4%

The company can borrow from its bank at 9% per year

The company’s marginal tax rate: 35%

The market value of the company’s assets is $160 million financed by $54.40 million in debt and the rest in equity

Answer 1

The weighted average cost of capital is computed as shown below:

= cost of debt x (1 - tax rate) x weight of debt + cost of equity x weight of equity

cost of equity is computed as follows:

= Dividend just paid (1 + growth rate) / price of stock + growth rate

= $ 2.6 (1 + 0.04) / $ 30.04 + 0.04

= 13% or 0.13

So, the WACC will be as follows:

= 0.09 (1 - 0.35) x $ 54.40 million / $ 160 million + 0.13 x ( $ 160 million - $ 54.4 million) / $ 160 million

= 0.01989 + 0.0858

= 10.57% Approximately

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