You are a new Junior Analyst with the Wolverine Co., and you have collected the
ID: 2806526 • Letter: Y
Question
You are a new Junior Analyst with the Wolverine Co., and you have collected the following data: The yield on the company's outstanding bonds is 7.75%; its tax rate is 40%; the firm’s common stock is expected to pay a dividend of $0.65 a share; the dividend is expected to grow at a constant rate of 6.00% a year; the current price of the stock is $15.00 per share; the flotation cost for selling new shares is F = 10%; and the target capital structure is 45% debt and 55% common equity.
a. What is the firm’s WACC if it uses debt and retained earnings to finance its capital budget?
Explanation / Answer
Cost of debt after tax=7.75(1-0.4)=4.65%
Cost of retained earnings=(D1/P0)+Growth rate
=(0.65/15)+0.06
=10.33%(Approx)
WACC=Respective costs*Respective weights
=(4.65*0.45)+(10.33*0.55)
which is equal to
=7.78%(Approx).
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