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Today, 04:49

Avido Inc. is expected to pay a $2.00 dividend at year end (D1 = $2.00), the dividend is expected to grow at a constant rate of 4.50% a year, and the common stock currently sells for $47.00 a share. The before-tax cost of debt is 6.50%, 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? 5.98% 6.57% 7.22% 6.91% 5.77%

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  1. Today, 08:47
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    6.57%

    Explanation:

    Given that,

    D1 = $2.00

    Dividend growth rate, g = 4.50%

    Stock price, P0 = $47

    Before-tax cost of debt = 6.50%

    Tax rate = 40%

    Target capital structure for Debt = 45%

    Target capital structure for Common equity = 55%

    Cost of equity:

    = (D1 : P0) + g

    = ($2.00 : $47) + 4.50%

    = 4.25% + 4.50%

    = 8.75%

    After tax cost of dept:

    = Before tax cost of dept * (1 - Tax rate)

    = 6.50% * (1 - 0.40)

    = 6.50% * 0.60

    = 3.9%

    Company's WACC if all the equity used is from retained earnings:

    = (Cost of equity * Percent of common equity) + (After tax cost of dept * Percent of debt)

    = (8.75% * 55%) + (3.9% * 45%)

    = 4.8125% + 1.755%

    = 6.57%
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