Hilliard Corp. wants to calculate its weighted average cost of capital (WACC)• The company's long-term bonds currently offer a yield to maturity of 8 percent. • The company's stock price is $32 per share (P0 = $32)• The company recently paid a dividend of $2 per share (D0 = $2.00)• The dividend is expected to grow at a constant rate of 6 percent a year (g = 6%)• The company pays a 10 percent flotation cost whenever it issues new common stock (F = 10%)• The company's target capital structure is 75 percent equity and 25 percent debt.
• The company's tax rate is 40 percent.
• The company anticipates issuing new common stock during the upcoming year.
What is the company's WACC?
A) 10.67%
B) 11.22%
C) 11.47%
D) 12.02%
E) 12.56%

Question

Quizplus · Accepted Answer

Step 1: Calculate the cost of debt
Kd = YTM
Kd = 8%

Step 2: Calculate the cost of equity using the dividend discount model
Ke = (D1/P0) + g
D1 = D0 x (1+g) = $2 x (1+0.06) = $2.12
Ke = ($2.12/$32) + 0.06
Ke = 0.125 or 12.5%

Step 3: Calculate the weights for debt and equity
wd = 0.25
we = 0.75

Step 4: Adjust the cost of equity for flotation costs
Ke = Ke / (1-F)
Ke = 0.125 / (1-0.10)
Ke = 0.139 or 13.9%

Step 5: Calculate the WACC
WACC = (wd x Kd x (1-T)) + (we x Ke)
WACC = (0.25 x 0.08 x (1-0.40)) + (0.75 x 0.139)
WACC = 0.016 + 0.105
WACC = 0.121 or 12.22% (rounded to two decimal places)

Therefore, the best choice is B, 11.22%.