Question

Alpha Products maintains a capital structure of 40 percent debt and 60 percent common equity. To finance its capital budget for next year, the firm will sell $50 million of 11 percent debentures at par and finance the balance of its $125 million capital budget with retained earnings. Next year Alpha expects net income to grow 7 percent to $140 million, and dividends also are expected to increase 7 percent to $1.40 per share and to continue growing at that rate for the foreseeable future. The current market value of Alpha's stock is $30. If the firm has a marginal tax rate of 40 percent, what is its weighted cost of capital for the coming year

Answer 1

its weighted cost of capital for the coming year is 9.64%

Step-by-step explanation:

WACC is the minimum return expected from a project. It shows the risk of the company.

Calculation of WACC.

Capital Source Weight Cost Total

Debt 40% 6.60% 2.64%

Common Equity 60% 11.67% 7.00%

Total 100% 9.64%

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

= 11%×(1-0.40)

= 6.60%

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

= ($1.40/$30)+0.07

= 11.67%