Question

Noogle Ltd, is a rapidly growing chain of retail stores. A security analyst’s report indicates that debt yielding 8% composes 25% of Noogle’s overall capital structure. Furthermore, Noogle’s dividends are expected to grow at a rate of 9% per year.

The company should pay $1.50 per share in dividends during the coming year. The risk free rate is currently equal to 2% and the expected return on the SP 500 index is 10%. The company’s estimated beta is 1.5. Assuming a 40% tax rate, calculate Noogle’s weighted average cost of capital.

Answer 1

Answer : Noogle Ltd WACC = 11.7%

Solution:

Key Notations :

a) Weight of Debt (W_d)= 25% i.e 0.25

b) Weight of Equity (W_e)= 1-0.25 = 0.75

c) After Tax Cost of Debt (K_d) = 8%(1-0.40) = 4.8%

d) Cost of Equity (K_e) = Rf + (Rm-Rf)β

                                      = 2 +(10-2)1.5

                                       =14%

    

Calculation of WACC

WACC = W_e(K_e) + W_d(K_d)

            = 0.75(14) +0.25(4.8)

            = 11.7 %