Assume that you are on the financial staff of Vanderheiden Inc, and you have col

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, what is the firm's WACC, assuming it must issue new stock to finance its capital budget? a. 7.6496 b. 7.26% ?c. 8.44% O d. 8.0496 e. 6.89%

Explanation / Answer

Answer :d. 8.04%

Cost of debt =7.75%

Tax rate = 40%

After tax cost of debt = 7.75%(100-40%) = 4.5%

Dividend in year 1 (D1) = $0.65

Growth rate (g) = 6%

Current market price (P0) = $15

Flotation costs(F) = 10%

P0(1-F) = D1 / Ke-g

Ke = [ D1 / P0(1-F) ]+ g

Ke = [ 0.65 / 15(1-0.10)]+0.06

Ke = 0.1081 i.e 10.81%

WACC = Cost of debt*weight of debt+Cost of equity*weight of equity

WACC = 0.048*0.45+0.1081*0.55

WACC = 8.04%

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