Lum & Co. has a target capital structure of 60% debt and 40% common equity, with
ID: 2628151 • Letter: L
Question
Lum & Co. has a target capital structure of 60% debt and 40% common equity, with no preferred stock. The frim's cost of common equity is 12.5% and its WACC is 8.444%. If the frims tax rate is 30%, what is the before-tax yield on Lum's long-term debt?
8.8
8.6
8.2
10.0
9.4
Lum can finance its capital budget with retained earnings throughout the foreseeable future, and its stock price is expected to grow at a constant rate. Lum's expected lon-run sustainable return on equity (ROE) is 15%, and the firm expects to maintain its dividend payout ratio of 60%. If Lum uses the DCF approach to calculate its cost of retained earnings, what is the expected dividend yield on Lum's stock?
6.5
2.9
6.1
4.5
3.5
Explanation / Answer
Lum & Co. has a target capital structure of 60% debt and 40% common equity, with no preferred stock. The frim's cost of common equity is 12.5% and its WACC is 8.444%. If the frims tax rate is 30%, what is the before-tax yield on Lum's long-term debt?
Weight of Debt60%Weight of Equity40%
Cost of Equity12.50%WACC8.444%
Tax Rate308.444% = .4*12.5% + .6*(1-.3)*Wd
Therefore, Wd = (8.444% - .4*12.5%)/(.6*(1-.3))
Before Tax Yield =8.20%
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