1. Mack Industries just paid a dividend of $1.00 per share. Analysts expect the
ID: 2699490 • Letter: 1
Question
1. Mack Industries just paid a dividend of $1.00 per share. Analysts expect the company's dividend to grow 20 percent this year, and 15 percent next year. After two years the dividend is expected to grow at a constant rate of 5 percent. The required rate of return on the company's stock is 12 percent. What should be the current price of the company's stock
2. BILLY Company%u2019s financial manager, Mr. thomson, has collected the following information to calculate its WACC:
%u2022 Wilee%u2019s capital structure consists of 40% debt and 60% common stock.
%u2022 Wilee has 25-year, 12% annual coupon bonds that have a face value of $1,000 and sell for $1,252.
%u2022 Wilee uses the CAPM to calculate the cost of common stock. Currently, the risk-free rate is 5% and the market risk premium is 6%. Wilee%u2019s common stock has a beta of 1.6. Wilee%u2019s tax rate is 40%.(7 points)
a. What is the company%u2019s after-tax cost of debt?
b. What is the company%u2019s cost of common equity?
c. What is the company%u2019s weighted average cost of capital (WACC)?
Explanation / Answer
. Mack Industries just paid a dividend of $1.00 per share. Analysts expect the company's dividend to grow 20 percent this year, and 15 percent next year. After two years the dividend is expected to grow at a constant rate of 5 percent. The required rate of return on the company's stock is 12 percent. What should be the current price of the company's stock
Current Price = 1*1.2/1.12 + 1*1.2*1.15/1.12^2 + (1*1.2*1.15*1.05/(0.12-0.05))/1.12^2 = $18.67
2. BILLY Companys financial manager, Mr. thomson, has collected the following information to calculate its WACC:
Wilees capital structure consists of 40% debt and 60% common stock.
Wilee has 25-year, 12% annual coupon bonds that have a face value of $1,000 and sell for $1,252.
Wilee uses the CAPM to calculate the cost of common stock. Currently, the risk-free rate is 5% and the market risk premium is 6%. Wilee%u2019s common stock has a beta of 1.6. Wilee%u2019s tax rate is 40%.(7 points)
a. What is the companys after-tax cost of debt?
After Tax cost of debt = 12*0.60 = 7.20%
b. What is the companys cost of common equity?
Cost of common equity = 5 + 6*1.60 =14.60%
c. What is the companys weighted average cost of capital (WACC)?
WACC = 7.20*40% + 14.60*60% = 11.64%
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