Assume that you are on the financial staff of Vanderheiden Inc., and you have co
ID: 2754966 • Letter: A
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 $19.00 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?
Explanation / Answer
Cost of equity = [D1/P0(1-f)] + g
= [$0.65/$19(1-0.1)] + 0.06
= 0.0980 or 9.80%
Cost of debt = 7.75%(1-0.40)
= 4.65%
WACC = 9.80%x0.55 + 4.65%x0.45
= 7.4825%