Question

CENGAGE MINDTAP Q Search this course A-Z Brigham Chapter 10 End-of-Chapter Problems Problem 10-8 Cost of Common Equity and WACC Palencia Paints Corporation has a target capital structure of 45% debt and 55% common equity, with no preferred stock. Its before-tax cost of debt is 10% and its marginal tax rate is 40%. The current stock price is Po = $29.00. The last dividend was Do = $2.50, and it is expected to arow at a 6% constant rate. What is its cost of

Answer 1

Weight of Debt = 45%
Weight of Equity = 55%

Before-tax Cost of Debt = 10.00%
Tax Rate = 40%

After-tax Cost of Debt = Before-tax Cost of Debt * (1 - Tax Rate)
After-tax Cost of Debt = 10.00% * (1 - 0.40)
After-tax Cost of Debt = 6.00%

Last Dividend, D0 = $2.50
Current Price, P0 = $29.00
Growth Rate, g = 6.00%

D1 = D0 * (1 + g)
D1 = $2.50 * 1.06
D1 = $2.65

Cost of Equity = D1 / P0 + g
Cost of Equity = $2.65 / $29.00 + 0.06
Cost of Equity = 0.1514 or 15.14%

WACC = Weight of Debt * After-tax Cost of Debt + Weight of Equity * Cost of Equity
WACC = 0.45 * 6.00% + 0.55 * 15.14%
WACC = 11.03%