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:

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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? 

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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%.

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