Watta company has only common equity and bonds. You are asked to estimate Watta
ID: 2803915 • Letter: W
Question
Watta company has only common equity and bonds. You are asked to estimate Watta Company's WACC and you have the following information: Watta's last stock dividend was $1.20 per share. Its dividend is expected to grow at 8% indefinitely. The stock currently sells for $50 per share. Watta has a target debt-equity ratio of 0.40/0.60 and it can sell 9% 10-year coupon bonds at par value. The average gong market interest rate for other companies' debts currently is 10%. If the tax rate is 35%, what is the WACC? (The company does not have any preferred stocks).
Explanation / Answer
price = dividend next year /(required rate of return - growth rate)
=>
50 = 1.2*1.08/(cost of equity - 8%)
cost of equity = 10.6136%
debt + equity = 1
debt/equity = 0.4/0.6 = 2/3
=>
debt = 2/5 = 0.4
equity = 3/5 = 0.6
after tax cost of debt = 10% * (1-0.35)
= 6.5%
WACC = 0.4 * 6.5% + 0.6 * 10.6136%
= 8.97%
weighted average cost of capital
= weight of debt * cost of debt + weight of preferred stock * cost of preferred stock + weight of equity * cost of equity
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