ABC\'s capital structure is limited to common equity and bonds. Its target capit

Question

ABC's capital structure is limited to common equity and bonds. Its target capital structure calls for 72percent common equity and the rest long term debt. The company's outstanding bonds have a yield to maturity of 7.9 percent. The company's common stock, which sells for $65.01 per share, is expected to pay a dividend of $2.06 next and the dividend is expected to grow at a constant rate of 11.1 percent. Given its tax rate of 40 percent, what is ABC's weighted average cost of capital? (Show your answer in decimal for to three places, e.g., 12.3% would be entered as 0.123)

Explanation / Answer

Weight of debt=(1-0.72)=28%

Cost of debt after tax=7.9(1-0.4)=4.74%

Cost of equity=(Dividend for next period/Current price)+Growth rate

=(2.06/65.01)+0.111=14.2687432%

WACC=Respective costs*Respective weights

=(4.74*0.28)+(14.2687432*0.72)

=0.116(Approx)

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