Answer to Question #236707 in Economics for Samuel

Question

Welltodo Ltd has the following capital structure, which it considers to be optimal: debt = 15%, preferred stock = 20%, and common stock = 65%. FCI’s tax rate is 40%, and investors expect earnings and dividends to grow at a constant rate of 6% in the future. Welltodo paid a dividend of Gh₵4.70 per share last year (D0), and its stock currently sells at a price of Gh₵60 per share. Ten-year Treasury bonds yield 6%, the market risk premium is 5%, and Welltodo’s beta is 1.3. The following terms would apply to new security offerings. Preferred: New preferred could be sold to the public at a price of Gh₵100 per share, with a dividend of Gh₵9. Flotation costs of Gh₵5 per share would be incurred. Debt: Debt could be sold at an interest rate of 9%. Common: New common equity will be raised only by retaining earnings. Determine the company’s WACC?

Answer 1

The company’s WACC is:

$WACC = 0.65×(0.05 + 1.3×((4.7/60 + 0.06) - 0.05) + 0.15×0.09×(1 - 0.4) + 0.2×9/(100-5) = 0.125.$