Question

The GIN Corp. is expected to pay a dividend of $3 which is expected to grow at 2% for aforeseeable future. The stock of the GiN Corp. is currently selling at a market price of$40. The company recently expanded its operations by issuing 10-year Corporate bond atpar value ($1,000) which pays an annual coupon payment of $80. If the debt-equity ratioof the company is 0.40 and the corporate tax rate is 30%, what is the weighted averagecost of capital of the company?​

Answer 1

Answer B (8.38)

Let Kd is  cost of debt and  Wd  is proportion of debt.

Ke is  cost of equity and We is  proportion of equity.

Ko is weighted average cost of capital. T is the tax rate.

D  is expected dividend and g  is growth rate of dividend. MP is market price of the stock.

Ke  = (D/MP) + g = (3/40) + 0.02 = 0.075 + 0.02 = 0.095 = 9.5 %

Kd = [(Annual coupon payment/ Par value)](1-T)=[80/1000](1- 0.3)=[0.08](0.7)=0.056=5.6 %

Wd/We =0.4 [Given]

Wd=0.4We , again we know Wd + We =1 , 1.4We = 1, We=(1/1.4) = 0.7143

Wd = 0.4(0.7143) = 0.2857

Ko = WdKd + WeKe = 0.2857x5.6 + 0.7143x9.5 = 8.38 %