A firm's earnings break point equals $98 million. Its net income is $58 million and it is committed to a dividend payout ratio of 30%. It's after-tax cost of debt equals
9% and its shareholders demand an expected rate of return of 15%. The firm's WACC equals ________.
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A. B. C. D.C
The retained earnings of the firm = $58*0.7 = $40.6 million. If the earnings breakpoint is $98 million then the firm must issue $(98-40.6) = $57.4 million in debt to maintain constant D/E ratio. This implies that the firm's D/E ratio equals 57.4/40.6 = 1.41. Debt comprises 57.4/98 = 58.57% of the capital structure. Therefore,
WACC = 0.5857*0.09 + 0.4143*15% = 11.49%.