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1 March, 22:33

Debbie's Donuts has 200,000 shares of common stock outstanding, which have a current market price of $25 a share. This year's annual dividend is expected to be $3.50 per share, with a growth rate of 2.5%. The firm also has 10,000 bonds outstanding with a yield to maturity of 6%. The bonds have a face value of $1,000 per bond, and are currently selling at 102% of par. If Debbie's donuts has a tax rate of 30%, what is the weighted average cost of capital?

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  1. 1 March, 23:01
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    8.36%

    Explanation:

    Data provided in the question:

    Number of stocks outstanding = 200,000

    Current market price = $25

    Dividend paid, D1 = 3.5

    Growth rate = 2.5% = 0.025

    Bonds outstanding = 10,000

    Yield to maturity = 6%

    Current selling price = 102% of par

    Now,

    Total value of Common stock

    = Number of stocks outstanding * Market price

    = 200,000 * $25

    = $5 million

    Cost of equity = (D1 : Current price) + Growth rate

    = [ (3.5 * (1 + 0.025)) : 25 ] + 0.025

    = 16.85%

    Total value of bonds = 10000 * (1000 * 102) %

    = $10.2 million

    After-tax cost of debt = yield to maturity * (1 - tax rate)

    = 6 * (1 - 0.3)

    = 4.2%

    Total value = (5 + 10.2)

    = $15.2 million

    WACC = Respective costs * Respective weight

    = (5 : 15.2) * 16.85 + (10.2 : 15.2) * 4.2

    = 8.36%
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