Palencia paints corporation has a target capital structure of 35% debt and 65% common equity, with no preferred stock. its before-tax cost of debt is 8%, and its marginal tax rate is 25%. the current stock price is p0 = $29.00. the last dividend was d0 = $2.25, and it is expected to grow at a 6% constant rate. what is its cost of common equity and its wacc? do not round intermediate calculations. round your answers to two decimal places.

THE COST OF EQUITY IS 14.2% AND WACC IS 11.33%

Explanation:

Here in the question we have been given the weight of debt(35% debt) and weight of equity(65% equity), with marginal tax rate as 25%, PO which is current stock price as $29 and DO which is he last dividend as $2.25, and lastly with growth rate of 6%.

So for us to calculate the cost of common equity, we have to use the approach of discounted cash flow(DCF), where we will us the formula of -

   Dividend in the first year (D1)  /  Current price of stock (PO)  + growth rate

Here we know the value of PO and growth rate but don't know the D1, so firstl we will have to calculate the D1 using formula  =

   D1 = D0 (1+GROWTH RATE)

        = $2.25 ( 1+6%)

        = $2.25 (1+.06)

        = $ 2.385

Now putting the value of D1 in cost of common equity formula,

  = $2.385 / $29 + 6%

  = .082 + .06

  = .142 ( when multiplied by 100 to make in percentage we get 14.2%)

therefore the cost of common equity is 14.2%

For taking out WACC ( weighted average cost of capital ) we will use the formula of =

weight of debt [cost of debt(1 - marginal tax rate)] + weight of equity x cost

                                                                                                             of equity

=  35% [8%(1 - 25%)] + 65% x 14.2%

= .35 [.08(.75)] + .65 x .142

= .35 x .06 + .0923

= .021 + .0923

= .1133  ( multiplying  by 100 to make it in percentage)

= 11.33%

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