Anderson Enterprises, Inc. has determined its optimal capital structure, which i
ID: 2634359 • Letter: A
Question
Anderson Enterprises, Inc. has determined its optimal capital structure, which is composed of the following sources and target market value proportions: Source of Capital: Target Market Proportions: Long-Term Debt 60% Common Stock Equity 40% The pre-tax interest rate on new $2,000 par value bonds that Anderson Enterprises may issue is 8%. The firms common stock is currently selling for $74.00 per share. The dividend expected to be paid at the end of the coming year (D1) is $5.00. The firms dividend payments have been growing at a constant rate of 3% for the last five years The firms marginal tax rate is 40%.
a. Calculate Anderson Enterprises after-tax cost of debt financing.
b. Calculate Anderson Enterprises cost of retained earnings.
c. Assume that Anderson Enterprises plans to finance a warehouse expansion utilizing retained earnings, together with debt financing, in the target capital structure proportions provided in the chart above. Calculate Anderson Enterprises a Weighted Average Cost of Capital (WACC).
Explanation / Answer
a>Cost of debt=Interes Rate*(1-Tax Rate)0.08*(1-.40) 0.048 or 4.8% b>Cost of retained earning =(Dividend/Share Price)+ growth rate of dividend=(5/74)+0.03 0.098 or 9.8% c>WACC=0.6*0.048+0.4*0.098 0.068 or 6.8%