Sheehan Corporation estimates that it can issue debt at a rate of r d = 8%, and

Question

Sheehan Corporation estimates that it can issue debt at a rate of rd = 8%, and its tax rate is 35 percent. It can issue preferred stock that pays a constant $5.50 dividend per year at a price of $60 per share. Also, its common stock currently sells for $30 per share, the next expected dividend (D1) is $1.50, and the dividend is expected to grow at a constant rate of 8 percent per year. The target capital structure consists of 50 percent common stock, 40 percent debt, and 10 percent preferred stock. What is Sheehan’s WACC?

Explanation / Answer

After tax cost of debt=8(1-0.35)=5.2%

Cost of preferred stock=Annual dividend/Current price

=(5.5/60)=9.167%

Cost of equity=(D1/P0)+Growth rate

=(1.5/30)+0.08=13%

WACC=Respective costs*Respective weights

=(5.2*0.4)+(13*0.5)+(9.167*0.1)

which is equal to

=9.50%(Approx).

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