Question

If its current tax rate is 25%, how much higher will Turnbull’s weighted average cost of capital (WACC) be if it has to raise additional common equity capital by issuing new common stock instead of raising the funds through retained earnings? (Note: Round your intermediate calculations to two decimal places.)

-0.76%

-1.03%

-0.95%

-0.65%

Answer 1

To calculate the increase in Turnbull’s weighted average cost of capital (WACC) if it has to raise additional common equity capital by issuing new common stock instead of using retained earnings, we need to compare the cost of equity for the different methods. Option D is correct.

Step-by-step explanation:

To calculate the increase in Turnbull’s weighted average cost of capital (WACC) if it has to raise additional common equity capital by issuing new common stock instead of using retained earnings, we need to compare the cost of equity for the different methods.

When raising funds through retained earnings, there is no cost of equity, as the firm is using its own profits. However, when issuing new common stock, the cost of equity can be calculated using the dividend growth model.

Let's assume that the dividend per share is $1.50 and the expected growth rate is 5%. The cost of equity can be calculated as follows:

Cost of equity = Dividend per share / Stock price + Growth rate = $1.50 / Stock price + 0.05

Given that the tax rate is 25%, we can calculate the increase in WACC as:

Increase in WACC = Tax rate * Cost of equity = 0.25 * ($1.50 / Stock price + 0.05)

By substituting the given tax rate of 25% into the equation, we can calculate the increase in WACC.