Assume that you are on the financial staff of Vanderheiden Inc., and you have co
ID: 2805032 • 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 $17.00 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
After tax cost of debt=7.75(1-0.4)=4.65
Cost of equity=(Dividend for next period/Current price(1-floatation cost))+Growth rate
=0.65/(17(1-0.1))+0.06
=0.65/15.3+0.06
=10.248366%
WACC=Respective costs*Respective weights
=4.65*0.45+10.248366*0.55
=7.73%(Approx).