Frankenstein Electric has a capital structure that consists of 60 percent eq lon

Question

Frankenstein Electric has a capital structure that consists of 60 percent eq long-term b determine the cost of e vield to maturity of 7 percent. The company uses the DCF approach to are, and the dividend is expected to grow forever at a constant rate of 9 4) s have a before-tax to be $2perommon stock currently trades at $40 per share. The year-end Frankenstein's $2 per sh is expeeted percent a year. The company estimates that it will have to issue new common stock to help fund this year's projects. The flotation cost on new commo What is the company's weighted average cost of capital, WACC? A. 10.6% n stock issued is 15 percent, and the company's tax rate is 40 percent. It o.0) lo C. 11.0% 10.1% D, E. 8.9% Colone. -015

Explanation / Answer

Weight of Debt = 40%
Weight of Equity = 60%

Before-tax Cost of Debt = Before-tax Yield to Maturity
Before-tax Cost of Debt = 7.0%

After-tax Cost of Debt = Before-tax Cost of Debt * (1 - tax)
After-tax Cost of Debt = 7.0% * (1 - 0.40)
After-tax Cost of Debt = 4.20%

Next Year Dividend, D1 = $2
growth rate, g = 9%
Current Price, P0 = $40
Flotation Cost, F = 15%

Cost of Equity = D1 / [P0*(1-F)] + g
Cost of Equity = $2 / [$40*(1-0.15)] + 0.09
Cost of Equity = 0.1488
Cost of Equity = 14.88%

WACC = Weight of Debt*After-tax Cost of Debt + Weight of Equity*Cost of Equity
WACC = 40%*4.20% + 60%*14.88%
WACC = 10.6%

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