Weighted Average Cost of Capital (WACC)

Ms. Matthews wants you to use the weighted average cost of capital (WACC) as the required return. ACH currently has 10 million common shares that are trading at $30 per share. The dividend is expected to increase to $3.00 per share in the next period. ACH also has 1 million preferred shares that get $1M in dividends and are currently trading at $20 per share. Ms. Matthews wants you to determine the cost of preferred equity and common equity, using dividends and share prices. The anticipated constant growth rate for common dividends is 2%.

The total market value of debt ACH expects to have going into this investment is $120M. The before-tax cost of debt is approximately 8%, excluding the impact of re-financing at a lower rate of 6% for $50M. Ms. Matthews wants you to use the 8% interest rate as the proxy for the cost of debt, but needs you to determine the after-tax cost of debt to be used in the WACC. A tax rate of 25% has been suggested for use in the analysis.