Dolittle Daires has a capital structure which consists of 60% long-term debt and 40% common stock. The company’s CFO has obtained the following info:
* The before-tax YTM on the company’s bonds is 8%.
* The company’s tax rate is 40%.
* The company stock is expected to pay a $3 dividend at year end (DIv1 = $3) and the dividend is expected to grow at a constant rate of 7% a year. The common stock currently sells for $60/share (EPS0).
* Assume the firm will be able to use retained earnings to fund the equity portion of its capital budget.
What is Dolittle Dairies WACC?
Answer: WACC= 7.68%
Working notes for the above answer is as under
We have been provided with the information as folllo
The before-tax YTM on the company’s bonds is 8%.
The company’s tax rate is 40%.
The company stock is expected to pay a $3 dividend at year end (DIv1 = $3) and the dividend is expected to grow at a constant rate of 7% a year.
The common stock currently sells for $60/share (EPS0).
The firm will not be issuing new equity because there are adequate retained earnings available to fund available projects. Therefore, WACC should be calculated using rs.
rs
= D1/P0 + g
= $3.00/$60.00 + 0.07
= 0.12 = 12%.
WACC
= wdrd(1 – T) + wcers
= (0.6)(0.08)(1 – 0.4) + (0.4)(0.12)
= 0.0768 = 7.68%.
