Question

Kuhn does not have any retained earnings available to finance this project, so the firm will have to issue new common stock to help fund it. Its common stock is currently selling for $33.35 per share, and it is expected to pay a dividend of $1.36 at the end of next year. Flotation costs will represent 3% of the funds raised by issuing new common stock. The company is projected to grow at a constant rate of 8.7%, and they face a tax rate of 25%. What will be the WACC for this project

Answer 1

Answer:

WACC = 12.9%

Explanation:

The cost of common stock can be determined using the dividend valuation model.

According to the dividend valuation, the value of a stock is the present value of expected future dividends discounted at the required rate of return.  

The model can me modified to determined the cost of equity having flotation cost as follows:  

Cost of equity = D(1+r )/P(1-f) + g  

d- dividend, p- price of stock , f - flotation cost , - g- growth rate  

Cost of common stock  for Kuhn

D(1+r) =1.36  , g- 5%, P= 33.35, f-3% g-8.7%

Cost of common stock = 1.36/(33.35× (1-0.03)) + 0.087= 12.9%

WACC = 12.9%

Note the tax rate is not needed for this calculation