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palencia Paints Corporation has a target capital structure of 35% debt and 65% common equity, with no preferred stock
palencia Paints Corporation has a target capital structure of 35% debt and 65% common equity, with no preferred stock. Its before-tax cost of debt is 10%, and its marginal tax rate is 25%. The current stock price is Pa = $27.00. The last dividend was Do = $3.00, and it is expected to grow at a 5% constant rate. What is its cost of common equity and its WACC? Do not round intermediate calculations. Round your answers to two decimal places. Is = WACC =
Expert Solution
Using Dividend Discount Model (DDM), Price of a stock can be calculated using the formula: D1/(r-g); where D1 is dividend paid next year, r is required rate of return and g is constant growth rate of dividend.
Given the dividend last year is $3.00. So, Dividend paid next year, D1= 3.00*(1+5%)= $3.15
So, 27= 3.15/(r-5%)
r= 16.67%
Cost of equity, rs= 16.67%
WACC can be calculated as (Weight of Equity*Cost of Equity)+(Weight of Debt* Cost of debt*(1-tax rate))
WACC= (65%*16.67%)+(35%*10%*(1-25%))= 13.46%
WACC= 13.46%
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