Question

AaabCeDdEe> LA AaBbCcDdEe AaBbCeDdEe AaBbCcDc AaBbCc Aa Bb Cc Dd Ee Aa BbAaBbccD dEe ab x, x Normal No Spacing Heading 2 Styles Pane A A Heading 1 Heading 3 Title Subtitle Subte Emph. The firm makes changes to its operations and capital structure and as a result the rates of return required by investors (buyers of bonds and equity) change You need to calculate the weighted average cost of capital (WACC) in this step of the project Scenario Steps to Completion 6. Calculate the company's weighted average cost of capital (WACC) under the following assumptions provided by Sue The company's long-term bonds (in the new capital structure) currently offer a yield to maturity of 8 percent The company's stock price (in the new capital structure) is $90 per share (P0 $90). The company will pay a dividend of $4.00) per share next year (D1 - The dividend is expected to grow at a constant rate of 6 percent a year (g 6% . The company's capital structure is 75 percent equity and 25 percent debt. The company's income tax rate is 40 percent What is the firm's WACC in this new capital structure? Why do we need to be concerned with the WACC?

Answer 1

Kd (BT) Solution Weighted Average cost of co Jeighted Average cost of capital - ? ( WACC) --- Yieldto maturing f the long teom bords = 8% (Po) company's stock price = $90 D.) Dividend wice pay next year = $4.00 (9) Dividend is expected to grow at a constars Rate= 6% Company Capital Storclube 75% equity and if, 0.75 . 25% Debt . Onax Rate = 40% OR 0.40. calculation of weighted Average cost of cable - OR0.06 . After tox - Kd (BT for the calculation of WACC, first of all we will - find the cost of debt Aflator cost of debt. 3 Before tax cost of debt *l – tox) . Ka(AT) Kd(AT) = 80%*(1-0.40) Kd(AT) =8%80:60 = 4.80%. KaCAT) = 4.00%

. We will calculate the cost of equity ke As we knew the dividend growth model, . formnia, Po = Dog $90 $4.00 Ke-0.06 $90 ( Ke -0.06) 0 = $4.00 $90 ke- $5.40 = $4.00 $ 90 ke= $ 9.00 ke = $9.40 =0.1044 - 7$ 90 : ke)=10.44 % Cost of equity formnia of WACE WACC = cost of equityx %4 equity + After tax costqclebt*%f Debt WÁCC - 10.44% X 0.75 +4.00% 0.25 VACC = 7,03% +1,2% .9.03% I WACC is the minimum sere of I WACC = 9.03% Relam or cutoft Rale or huidie baie for any project in capital Budgeting deuston ngths the minimum Requirement for the project. It is the date of Relum that a trom: must eam anih proiects investment .