Question

Palencia Paints Corporation has a target capital structure of 30% debt and 70% common equity, with no preferred stock. Its before-tax cost of debt is 9%, and its marginal tax rate is 25%. The current stock price is P0 = $21.50. The last dividend was D0 = $2.25, and it is expected to grow at a 5% constant rate. What is its cost of common equity and its WACC? Do not round intermediate calculations. Round your answers to two decimal places.

Answer 1

Value of Stock =

21.50 =

21.50 * Rate of Return - 0.05 * 21.50 = 2.3625

21.50 * Rate of Return - 1.075 = 2.3625

Rate of Return = (2.3625 + 1.075) / 21.50

Rate of Return = 3.4375 / 21.50

Rate of Return = 15.99% / 16%  

WACC = (Cost of Equity * Weight of Equity) + (Cost of Debt after tax * Weight of Debt)

= 16% * 0.70 + 9%(1-0.25) * 0.30

= 13.225% OR 13.23%

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