Christensen Cabinet Works maintains a debt-equity ratio of 0.65 and has a tax ra

Question

Christensen Cabinet Works maintains a debt-equity ratio of 0.65 and has a tax rate of 32 percent. The firm does not issue preferred stock. The pre-tax cost of debt is 9.8 percent. There are 25,000 shares of stock outstanding with a beta of 1.2 and a market price of $19 a share. The current market risk premium is 8.5 percent and the current risk-free rate is 3.6 percent. This year, the firm paid an annual dividend of $1.10 a share and expects to increase that amount by 2 percent each year. Using an average expected cost of equity, what is the weighted average cost of capital?

Explanation / Answer

Re = 0.036 + 1.2(0.085) = 0.138

Re = [($1.10 1.02)/$19] + 0.02 = 0.0790526

Re Average = (0.138 + 0.0790526)/2 = 0.108526

WACC = (1/1.65) (0.108526) + (0.65/1.65) (0.098) (1 - 0.32) = 9.20 percent

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