Description
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
Explanation & Answer
Attached.
Surname 1
Name:
Professor:
Course:
Date:
WACC and Corporate Investment
WACC= E/V*Re + D/V*Rd (1-Tc)
Where:
Re= cost of equity
Rd= cost of debt
E= market value of the firm’s equity
D= market value of the firm’s debt
V= total market value of the firm’s financing (equity + debt)
E/V= percentage of financing that is equity
D/V= percentage of financing that is debt
Tc= corporate tax rate
Wilson Corporation WACC
Re= 60%
Surname 2
Rd= 40%
E= 50
D= 2.50
V=52.25
E/V= 0.96
D/V= 6%
Tc= 35%
WACC= 0.96*0.6 + 0.06*0.4(1-0.35)
= 0.576 + 0.0156
= 0.5916 or 59.16%
Using the dividend discount model
Price per share= D (1)/ (r-g)
D (1) = estimated of next year’s dividend
r = company’s cost of equity capital
g = constant growth rate for dividends
D (1) = $2.50
r = 6%
Surname 3
g = 4%
Price per share = 2.50/ (6%-4%)
= $125
2.
In the event that a company decides to increase the amount of long-term debt then this
will lead to a decrease in the WACC. An increase in t...
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