Problem 10-8 Cost of Common Equity and WACC Palencia Paints Corporation has a ta
ID: 2790060 • Letter: P
Question
Problem 10-8
Cost of Common Equity and WACC
Palencia Paints Corporation has a target capital structure of 35% debt and 65% common equity, with no preferred stock. Its before-tax cost of debt is 9% and its marginal tax rate is 40%. The current stock price is P0 = $30.00. The last dividend was D0 = $2.50, and it is expected to grow at a 5% constant rate. What is its cost of common equity and its WACC? Round your answers to two decimal places. Do not round your intermediate calculations.
rs = _________%
WACC = __________ %
Explanation / Answer
price = dividend next year /(required rate of return - growth rate)
=>
D1 = Do * (1+r)
= 2.5 * ( 1+ 5%)
= 2.625
=>
30 = 2.625/r-5%
=>
cost of common equity rs = 13.75%
weighted average cost of capital
= weight of debt * cost of debt + weight of equity * cost of equity
= 0.35 * 9% * (1-0.4) + 0.65 * 13.75%
= 10.83%
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