Touring Enterprises, Inc., has a capital structure consisting of $18 million in

Question

Touring Enterprises, Inc., has a capital structure consisting of $18 million in long-term debt and $7 million in common equity. There is no preferred stock outstanding.

The interest rate paid on the long-term debt is 10%. The firm is in the 35% tax bracket.

On the common equity (stock), the Company pays an annual dividend of $1.20 and expects to increase the dividend by 5% per year. The market price of the stock is $50.

Based on this information, answer the following questions:

1. Calculate Touring Enterprises' weighted average cost of capital (WACC). Work as follows: first, compute the after-tax cost of debt, then compute the cost of equity. Cite both formulas, and show all your work.

Explanation / Answer

After tax cost of debt = 10 (1-0.35) = 6.5% answer Cost of equity = 50 = 1.2(1+0.05)/ke - 0.05 Solving for Ke = 7.52% asnwer WACC = 7/25*7.52% + 18/25*6.5% = 2.1056 + 4.68 = 6.78% answer

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