# wk5-P1 - a. What is the cost of common equity? D0 = \$1.25;...

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Bob’s Country Bunker (BCB), a chain of economically priced motels in the Midwestern United States has reviewed its current target structure of 40% debt and 60% equity. It can issue debt at a rate of 9%. The last dividend paid on its stock was \$1.25. The company is doing very well and expects to maintain its current growth rate of 5%. The firm’s tax rate is 35%, and the common stock currently sells at \$29. The company is considering two projects: Project A which has an expected rate of return of 14%, and Project B which has an expected rate of return of 10%. Both projects are equally risky and the firm can accept both.

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Unformatted text preview: a. What is the cost of common equity? D0 = \$1.25; g = 5% D1 = 1.25 x 1.05 \$1.3125 P0 = \$29 Cost of equity = (D1/P0) + g [1.3125/29] + .05 9.5259% b. What is the WACC? WACC = (Weight of debt x After-tax cost of debt) + (Weight of equity x cost of equity) After-tax cost of debt = 9% x (1- .35) 5.85% WACC = (40% x 5.85%) + (60% x 9.5259%) 2.34% + 5.71554% 8.06% rounded c. Which projects should BCB accept? If both projects can be accepted if they are not mutually exclusive, the COMPANY CAN ACCEPT BOTH. The reason is that both projects generate returns more than the WACC of 8.06%...
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## This document was uploaded on 05/02/2011.

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wk5-P1 - a. What is the cost of common equity? D0 = \$1.25;...

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