Question

Palencia Paints Corporation has a target capital structure of 25% debt and 75% common equity, with no preferred stock. Its before-tax cost of debt is 11%, and its marginal tax rate is 40%. The current stock price is P0 = $29.00. The last dividend was D0 = $2.50, and it is expected to grow at an 8% constant rate. What is its cost of common equity and its WACC? Do not round intermediate calculations. Round your answers to two decimal places. rs = 17.31 % WACC = 14.61 %

Answer 1

Ke 0.173103448

WACC 14.63250%

Step-by-step explanation:

From the gordon model we determinate Ke

`(divends)/(return-growth) = Intrinsic \: Value`

`(divends)/(Price) = return-growth`

`(divends)/(Price) + growth = return`

D1 2.7 (we are given with D0 so we multiply by (1+g) to get D1

P 29

g 0.08

`$Cost of Equity =(2.7)/(29) +0.08`

Ke 0.173103448

Now we use this value to determinate the WACC

`WACC = K_e((E)/(E+D)) + K_d(1-t)((D)/(E+D))`

Ke 0.1731

Equity weight 0.75

Kd 0.11

Debt Weight 0.25

t 0.4

`WACC = 0.1731(0.75) + 0.11(1-0.4)(0.25)`

WACC 14.63250%