Description
Assignment Steps
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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.
Format your paper consistent with APA guidelines.
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Explanation & Answer
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Cost of Equity under DDM Approach
Dividend Growth Rate, g
Next Year Dividend, D1
Current Stock Price, P0
Cost of Equity
4.00%
$2.50
$50.00
9.00%
*** Cost of Equity, K = (D1/P0) + g
Weighted Average Cost of Captial (WACC)
WACC Calculation (With Existing Capital Structure)
Sources
Common Stock
Long Term Debt
WACC
Target
Weight
Cost of Fund
60.00%
40.00%
9.00%
6.00%
Applicable After Tax Cost
Tax Rate
of Fund
0.00%
35.00%
9.00%
3.90%
Weighted
Cost
5.40%
1.56%
6.96%
WACC Calculation (With New Proposed Capital Structure)
Sources
Common Stock
Long Term Debt
WACC
Target
Weight
Cost of Fund
40.00%
60.00%
9.00%
6.00%
Applicable After Tax Cost
Tax Rate
of Fund
0.00%
35.00%
9.00%
3.90%
Weighted
Cost
3.60%
2.34%
5.94%
Introduction
Several decisions undertaken by the financial manager include capital budgeting
decision, capital structure decision, working capital decision, dividend decision etc. (Petty,
Titman, Keown, & Martin, 2015). The capital stru...