Sorensen Systems Inc is expected to pay a dividend of 410 at

Sorensen Systems Inc. is expected to pay a dividend of $4.10 at year end (D), 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? Your answer should be between 7.36 and 12.57, rounded to 2 decimal places, with no special characters.

Solution

D1 = $ 4.1 and Current Stock Price = P0 = $ 37.5

Growth Rate = 5.5 %

Cost of Equity = (4.1/37.5) + 0.055 = 0.1643 or 16.43 %

Before-Tax Cost of Debt = 7.5 %, Tax Rate = 40%, Target Debt = 0.45 and Target Equity = 0.55

Target WACC = 7.5 x (1-0.4) x 0.45 + 16.43 x 0.55 = 11.0615 or 11.06 % approximately.