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Sorensen Systems Inc. is expected to pay a $2.50 dividend at year end (D1 = $2.50), the dividend is expected to grow at a constant rate of 5.50% a year, and the common stock currently sells for $52.50 a share. The before-tax cost of debt is 7.50%, and the tax rate is 40%. The target capital structure consists of 45% debt and 55% common equity. What is the company's WACC if all the equity used is from retained earnings? 7.07% 7.36% 7.67% 7.98%

Respuesta :

Answer:

WACC = 7.67%

Explanation:

Firstly we will calculate cost of equity

Using dividend growth model we have

P0 = [tex]\frac{D1}{Ke - g}[/tex]

Where P0 = Current market price

D1 = Dividend at the end of year 1

Ke = Cost of equity

g = Growth rate

Here $52.5 = [tex]\frac{2.5}{Ke - 0.055}[/tex]

Ke - 0.055 = [tex]\frac{2.5}{52.5} = 0.0476[/tex]

Ke = 0.0476 + 0.055 = 0.1026 = 10.26%

Weighted cost of equity = 10.26% X 55 % = 5.643%

Cost of debt after tax = Cost of debt (1 - tax) = 7.5 X (1 - 40%) = 4.5%

Weighted cost of debt = 4.5 X 45% = 2.025%

Company's Weighted Average Cost = Weighted Average Cost of Debt + Weighted average cost of equity = 2.025 + 5.643

=7.67%

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