Question

Sorensen systems inc. is expected to pay a $2.50 dividend at year end (d1 = $2.50), the dividend is expected to grow at a constant rate of 5.50% a year, and the common stock currently sells for $37.50 a share. the before-tax cost of debt is 7.50%, and the tax rate is 40%. the target capital structure consists of 45% debt and 55% common equity. what is the company's wacc if all the equity used is from retained earnings? do not round your intermediate calculations.

Answer 1

the company's wacc is 8.72 %

Step-by-step explanation:

Weighted Average Cost of Capital (WACC) is the minimum return that a project must offer before it can be accepted.

WACC Calculation are as follows :

Capital Source Weight Cost Total

Common stock 55% 12.1666666 % 6.69166 %

Debt 45% 4.50 % 2.025%

Total 100% 8.72 %

Cost of Common Equity is Calculated as follows :

The data available allows us to use the Dividend Growth Model to calculated the cost of common equity.

Cost of Common Equity = (Next year`s Dividend/Current Market Price of a share) + Expected growth rate.

= ( $2.50/ $37.50) + 5.50%

= 12.1666666 %

Cost of Debt is Calculated as follows :

Cost of Debt = Interest × ( 1 - tax rate)

= 7.50% × ( 1 - 0.40)

= 4.50 %