2. Suppose that a stock in General Diversified Industries (GDI) has a beta of 1.

Question

2. Suppose that a stock in General Diversified Industries (GDI) has a beta of 1.7, The market risk premium is 7.6 percent, and the risk-free rate is 2.6 percent. GDI's last dividend was $1.70 per share, and the dividend is expected to grow at 5 percent indefinitely. What is the current pric? of the ?tock? po : 3. In addition to the information in the previous problem, suppose GDI has a target debtitotal asset ratio of 30 percent. Its cost of debt is 5 percent before taxes. If the tax rate is 25 percent, what is the WACC? t-

Explanation / Answer

Required return=Risk free rate+Beta*Market risk premium

=2.6+(1.7*7.6)=15.52%

Current price=D1/(Required return-Growth rate)

=(1.7*1.05)/(0.1552-0.05)

=$16.97(Approx).

2.

After tax cost of debt=5*(1-tax rate)

=5(1-0.25)=3.75%

Debt/Total assets ratio=0.3

Hence debt=0.3Total assets

Total asset=Debt+Equity

Hence equity=(1-0.3)Total assets

=0.7Total assets

WACC=Respective costs*Respective weights

(15.52*0.7Total assets/Total assets)+(3.75*0.3Total assets/Total assets)

=11.989%

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