Palencia Paints Corporation has a target capital structure of 25% debt and 75% common equity, with no preferred stock. Its before-tax cost of debt is 13%, and its marginal tax rate is 40%. The current stock price is P0 = $22.00. The last dividend was D0 = $3.00, and it is expected to grow at a 5% constant rate. What is its cost of common equity and its WACC? Round your answers to two decimal places. Do not round your intermediate calculations.

cost of common equity is 18.64%.

WACC is 15.93 %.

Explanation:

Cost of Equity is the return that is required by providers of Capital in form of Common Stocks.

This can be determined using the Growth Model as the information permits use of such method.

Cost of Equity = Current Dividend / Current Market Price + Expected Growth Rate

                       = $3.00 / $22.00 + 0.05

                       = 0.1864 or 18.64%

WACC = Ke × (E/V) + Kd × (D/V) + Kp × (P/V)

where,

Ke = cost of equity

    = 18.64%

E/V = Weight of Equity

      = 75%

Kd = cost of debt

     = Interest × (1 - market rate)

     = 0.13 × (1 - 0.40)

     = 0.078 or 7.80 %

D/V = Weight of Debt

       = 25%

Therefore,

WACC = 18.64% × 75% + 7.80 % × 25%

           = 15.93 %

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