Assume that you are an intern with the Nicholas Enchilada\'s Inc., and you have
ID: 2774527 • Letter: A
Question
Assume that you are an intern with the Nicholas Enchilada's 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 $0.50 a share; the dividend is expected to grow at a constant rate of 6.00% a year; the price of the stock is $25.00 per share; the flotation cost for selling new shares is F = 5%; and the target capital structure is 25% debt and 75% common equity. What is the firm's WACC, assuming it must issue new stock to finance its capital budget?
Explanation / Answer
Answer:
In absence of any information on total funds involved in the business we assume that the total capital involved in the business is $ 100,000 for ease of calculation which consist of $ 25,000 of outstanding bond with yield 7.75% and $ 75,000 common stock of $ 25.00 per share;
Now;
Cost of Equity Capital Ke = D0 (1 + g) / NP
here,
D0 = next expected dividend = $ 0.50 per share
g = expected growth in dividend = 6% = 0.06
NP = Net Proceeds from issue of share = $ 25 - 5% of $ 25 = $ 23.75
Ke = $ 0.50 (1 + 0.06) / $ 23.75 = 2.23%
Cost of Bond = 7.75 (1 - 0.40) = 4.65%
Therefore,
WACC = (75*2.23 / 100) + (25*4.65 / 100) = 2.835%