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Question: Kuhn does not have any retained earnings available to finance this project, so the firm will have to issue new common stock to help fund it. Its common stock is currently selling for $33.35 per share, and it is expected to pay a dividend of $2.78 at the end of next year. Flotation costs will represent 3% of the funds raised by issuing new common stock. The company is projected to grow at a constant rate of 9.2%, and they face a tax rate of 25%. What will be the WACC for this project? (Note: Round your intermediate calculations to two decimal places.)
Weighted Average Cost of Capital or WACC is the average cost to a company of the funds it has invested in the assets of the company. It does not directly use the tax rate or retained earnings in its basic calculation. However, to find the cost of new equity, we can use the Gordon Growth Model. The formula for Gordon Growth Model is: Cost of New Equity = Do(1+g)/(P0*(1 - FlotationCost)) + g Where: Do = Dividends expected at the end of next year = $2.78 g = growth rate = 9.2% = 0.092 P0 = Price of the stock = $33.35 FlotationCost = Flotation costs as a portion of the funds raised = 3% = 0.03 Plugging the values into the formula, we get: Cost of New Equity = 2.78(1 + 0.092) / (33.35 * (1 - 0.03)) + 0.092 Solve for the first part of the equation: = 2.78 * 1.092 / (33.35 * 0.97) Subtract the price after flotation costs and add the growth rate: = 0.091 + 0.092 Round up to two decimals, the Cost of New Equity is approximately 0.183 or 18.3% Please note that the WACC can't be calculated fully here as we do not have the required information about the firm's debt or preferred stock which are needed to calculate WACC: WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc) Where: E = Market value of equity V = Market value of equity + Market value of debt Re = Cost of equity (which we've just calculated) D = Market value of debt Rd = Cost of debt Tc = Corporate tax rate Make sure you have all these components in order to calculate the WACC for the project.
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