Scenario: Wilson Corporation (not real) has a targeted capital structure of 40% long term debt and 6

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Scenario: Wilson Corporation (not real) has a targeted capital structure of 40% long term debt and 60% common stock. The debt is yielding 6% and the corporate tax rate is 35%. The common stock is trading at $50 per share and next year's dividend is $2.50 per share that is growing by 4% per year.

Prepare a minimum 700-word analysis including the following:

  • Calculate the company's weighted average cost of capital. Use the dividend discount model. Show calculations in Microsoft® Word.
  • The company's CEO has stated if the company increases the amount of long term debt so the capital structure will be 60% debt and 40% equity, this will lower its WACC. Explain and defend why you agree or disagree. Report how would you advise the CEO.


Tutor Answer

Abdull
School: UIUC

Attached.

Running head: WILSON CORPORATION (WACC)

1

Name:

Institution:

Course name code & title:

Date:

WILSON CORPORATION (WACC)

2

Wilson Corporation (WACC)

The model assumes a consistent profit development rate in continuity. This suspicion is
for the most part safe for exceptionally developed organizations; however, new organizations
have fluctuating profit development rates in their starting years. The essential preferred
standpoint of the profit development show approach is its straightforwardness. It is both
straightforward and simple to utilize. Be that as it may, there are various related useful issues and
drawbacks.

Based on our scenario;

Wilson Corporation (not real) has a targeted capital structure of 40% long term debt and
60% common stock. The debt is yielding 6% and the corporate tax rate is 35%. The common
stock is trading at $50 per share and next year's dividend is $2.50 per share that is growing by
4% per year.

D (1) = the estimated value of next year's dividend

r = the company's cost of equity capital

g = the constant growth rate for dividends, in perpetuity

Using these variables, the equation for the GGM is:

Price per share = D (1) / (r - g)

WILSON CORPORATION (WACC)

D (1) = D (0) x (1 + g) =2.5/ (6%-4%) =$100

Therefore, cost of equity

Price per share= dividend/ (price per share* growth rate)

=100/ (2.5+0.04) =39.37%

As the percentage increases, it gradually reflects a higher debt proportion is utilized for
the permanent financing for the firm as opposed to investor funds. You have to have historical
data from the firm and/or industry data for comparison, however. As the proportion of debt gets
higher so does risk and the chance of bankruptcy. A decrease in the ratio would indicate that
there is an increase in stockholders' equity. I would therefore advice the CEO to carry on with
the idea.

Organizations regularly utilize debt while building their capital structure which brings
down aggregate financing cost. Notwithstanding the moderately brought down cost of debt
financing, utilizing debt has different favorable feedback compared to value financing. Potential
issues that may come along with utilizing debt include progressing budgetary liabilities and
potential insolvency. All in all, utilizing debt comes along with numerous benefits inside and
builds returns on value for current organization proprietors and secures charge reserve funds
(Myers, 2012).
Cost Reduction
Contrasted with value, debt requires bring down financing cost. Accordingly,
organizations regularly bl...

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Anonymous
Goes above and beyond expectations !

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