COST OF COMMON EQUITY AND WACC Palencia Paints Corporation h

COST OF COMMON EQUITY AND WACC Palencia Paints Corporation has a target capital structure of 25% debt and 75% common equity, with no preferred stock. Its before-tax cost of debt is 12%, and its marginal tax rate is 40%. The current stock price is Po-$31.50. The last dividend was Do = $3.50, and it is expected to grow at a 5% constant rate, what is its cost of common equity and its WACC? Round your answers to two decimal places. Do not round your intermediate calculations. a.rs- D. WACC =

Solution

Target Capital Structure: Debt = 25% and Equity = 75 %

Tax Rate = 40 % and Before-Tax Cost of Debt = 12 %

Stock Price = $ 31.5, D0 = $ 3.5, Dividend Growth Rate = 5 % and Expected Dividend = D1 = 3.5 x 1.05 = $ 3.675

Cost of Common Equity = r(s) = (D1/P0) + g = (3.675/31.5) + 0.05 = 0.1667 or 16.67 %

WACC = 12 x (1-0.4) x 0.25 + 16.67 x 0.75 = 14.3025 % or 14.3 % approximately.