Falcon Ridge Developers wants to compute the firm’s WACC for capital budgeting p
ID: 2712798 • Letter: F
Question
Falcon Ridge Developers wants to compute the firm’s WACC for capital budgeting purposes. The firm uses 30% debt, 10% preferred stock and the remainder is in equity. The YTM on the firm’s debt is currently 4.5% and the firm’s marginal tax rate is 40%. They pay a dividend of $3 on their preferred stock and the current price of the preferred stock is $75. Falcon’s most recent common dividend was also $3, but has been growing at a rate of 8% per year and is expected to continue that trend. The common stock is currently selling for $50. Calculate the firm’s WACC.
Explanation / Answer
Stock price = D1÷(r-g)
D1 is next expected dividend
r is cost of common stock
g is growth rate
$50 = $3×(1+8%)÷(r-8%)
Cost of common stock, r = 14.48%
WACC = Wd×Rd×(1-t)+ We×Ke+Wp×Rp
= 30%×4.5%×(1-40%)+60%×14.48%+10%×($3÷$75)×100
= 13.9%
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