Question

Judy's Boutique just paid an annual dividend of $2.41 on its common stock. The firm increases its dividend by 3.20 percent annually. What is the company's cost of equity if the current stock price is $38.68 per share?

a- 8.91%

b-9.17%

c-9.43%

d-10.00%

e-9.63%

The Two Dollar Store has a cost of equity of 10.9 percent, the YTM on the company's bonds is 5.6 percent, and the tax rate is 40 percent. If the company's debt–equity ratio is .45, what is the weighted average cost of capital?

a- 8.56%

b-9.13%

c-5.70%

d-8.21%

e-7.53%

Answer 1

1.Information provided:

Current dividend= $2.41

Growth rate of dividends= 3.20%

Current stock price= $38.68

The cost of equity is calculated is computed using the dividend discount model.

It is calculated using the below formula:

Ke=D1/Po+g

where:

D1= Next year’s dividend

Po=Current stock price

g=Firm’s growth rate

Ke= $2.41/ $38.68 + 0.0320

     = 0.0623 + 0.0320

     = 0.0943*100= 9.43%.

Therefore, the cost of equity is 9.43% and answer is option c.

2.Information provided:

Cost of equity= 10.9%

Cost of debt= 5.6%

Tax= 40%

Debt-equity ratio= 0.45

WACC is calculated by using the formula below:

WACC= wd*kd(1-t)+we*ke

where:

Wd=percentage of debt in the capital structure

We=percentage of equity in the capital structure

Kd=cost of debt

Ke=cost of equity

t= tax rate

Proportion of debt in the capital structure= 45%

Proportion of equity in the capital structure= 55%

WACC= 0.45*5.6*(1-0.40) + 0.55*10.9

            = 0.45*5.6*0.6 + 0.55*10.9

            = 1.5120 + 5.9950

            = 7.5070% 7.51%

Therefore, the answer is option e.