Question

Question 42 3 pts Sorensen Systems Inc. is expected to pay a $2.50 dividend at year end (D1 - $2.50), the dividend is expected to grow at a constant rate of 5,50% a year, and the common stock currently sells for $87.50 a share. The before-tax cost of debt is 7.50% and the tax rate is 25%. The target capital structure consists of 45% debt and 55% common equity. What is the company's WACC if all the equity used is from retained earnings? Do not round your intermediate calculations. 735% 5.10% 5.699 7.13% 6.62%

Answer 1

Given about Sorensen System,

Expected dividend D1 = $2.5

Growth rate g = 5.5%

current stock price P0 = $87.5

So, cost of equity using constant dividend growth model is

Cost of equity Ke = D1/P0 + g = 2.5/87.5 + 0.055 = 8.36%

Pretax cost of debt Kb = 7.5%

Tax rate T = 25%

Weight of debt Wd = 45%

Weight of equity We = 55%

So, WACC = Wd*Kd*(1-T) + We*Ke = 0.45*7.5*(1-0.25) + 0.55*8.36 = 7.13%

So, option D is correct.