Calculating the cost of equity Suppose stock in Boone Corporation has a beta of

Question

Calculating the cost of equity

Suppose stock in Boone Corporation has a beta of .90. The market rate premium is 7 percent, and the risk-free is 8 percent. Boone's las dividend was $1.80 per share, and the dividend is expected to grow at 7 percent indefinitely. The stock currently sells for $25. What is Boone's cost of equity capital?

Calculating the WACC.

In addition to the information in the previous problem, suppose Boone has a target debt-equity ratio of 50 percent. Its cost of debt is 8 percent, before taxes. If the tax rate is 34 percent, what is the WACC?

Explanation / Answer

1. Cost of equity can be find using CAPM model as well as using Dividend growth model.

Ke using CAPM = Rf + risk premium x Beta = 8 + 7 x 0.9 = 14.30%

Ke using Dividend growth model = D0(1+g)/P0 + g = 1.8(1+0.07)/25 + 0.07 = 14.7%

2. Cost of Debt(Kd) = interest rate x (1-tax rate) = 8 x (1-0.34) = 5.28%

a. WACC when Ke is 14.3%

WACC = (14.3 x 50%) + (5.28 x 50%) = 9.79%

WACC when Ke is 14.7%

WACC = (14.7% x 50%) + (5.28 x 50%) = 9.99%

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