Problem 10-8 Cost of Common Equity and WACC Palencia Paints Corporation has a ta

Question

Problem 10-8 Cost of Common Equity and WACC Palencia Paints Corporation has a target capital structure of 35% debt and 65% common equity, with no preferred stock. Its before tax cost of debt is 8% and its marginal tax rate is 40%. The current stock price is Po =23.50. The last dividend was D0 = $3.00, and it is expected to grow at a 5% constant rate. What is its cost of common equity and its WACC? Round your answers to two decimal places. Do not round your intermediate calculations. a, rs= b. WACC =

Explanation / Answer

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

=(3*1.05)/23.5+0.05=18.40%(Approx)

After tax cost of debt=8(1-0.4)=4.8%

WACC=Respective costs*respective weights

=(18.4*0.65)+(4.8*0.35)=13.64%(Approx)

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