QuestionDetails: A corporation has a target capital structure of 40% debt and 60
ID: 2770687 • Letter: Q
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QuestionDetails: A corporation has a target capital structure of 40% debt and 60%common equity, with no preferred stock. Its before tax costof debt is 12% and its marginal tax rate is 40%. The currentstock proce is P0 = $22.50. the last dividend was D0=$2.00and it is expected to grow at a constant rate of 7%. What isthe common equity and its WACC? QuestionDetails: QuestionDetails: A corporation has a target capital structure of 40% debt and 60%common equity, with no preferred stock. Its before tax costof debt is 12% and its marginal tax rate is 40%. The currentstock proce is P0 = $22.50. the last dividend was D0=$2.00and it is expected to grow at a constant rate of 7%. What isthe common equity and its WACC?Explanation / Answer
Target Capital Structure:
Debt = 40%
Equity =60%
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Total = 100%
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Dividend growth rate (g) =7%
Last Dividend (D 0) = $2.00
Current Stock Price (P0) = $22.50
Before tax Cost of Debt (R D) = 12%%
Corporate Tax Rate (T c) = 40%
Weighted Average Cost of Capital (WACC) =(E/V)*RE + (D/V)*RD(1-Tc)
E/V = 0.60
D/V = 0.40
Calculate the Return on Common Stock :
P0 = D1 / (R-g)
R = [ D1 / P0 ] + g
D1 = D0 (1+g)
= $2 (1+0.07)
D1 = $2.14
Return on Common Stock(RE) = [$2.14 / $22.50] +0.07
= 0.1651
= 16.51%
Return on Common Stock(RE) =16.51%
Weighted Average Cost of Capital (WACC) =(E/V)*RE + (D/V)*RD(1-Tc)
WACC = (0.60)*16.51% + (0.40)*12% (1-40%)
= (0.60)*0.1651 + (0.40)*0.12(0.6)
= 0.099 + 0.0288
= 0.1278 (or) 12.78
WACC=12.78%
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