CFA CFA Level 1 CFA Level 1 Question of the Week – Corporate Finance

CFA Level 1 Question of the Week – Corporate Finance

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    • Matt_AnalystPrep
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        An analyst gathered the following information about Altrian Corporation:

        Before-tax cost of new debt: 7%
        Corporate tax rate: 30%
        Target debt-to-equity ratio: 0.7
        Current stock price: $55
        Next year’s expected dividend: $4.5
        Estimated growth rate: 6%

        The company’s weighted average cost of capital (WACC) is closest to:

        • A. 10.36%
        • B. 8.40%
        • C. 12.44%
      • Matt_AnalystPrep
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          The correct answer is A.

          Cost of Equity = D1/P0 + g = 4.5/55 + 0.06 = 0.1418

          D/(D+E) = 0.7/1.7 = 0.4117

          WACC = wd * rd * (1-t) + wp * rp
          WACC = 0.4117 * 0.07 * (1-0.3) + (1-0.4117) * 0.1418 = 0.1036 or 10.36%

          Where

          wd = the proportion of debt that a company uses whenever it raises new funds

          rd = the before-tax marginal cost of debt

          t = the company’s marginal tax rate

          wp = the proportion of preferred stock that the company uses when it raises new funds

          rp = the marginal cost of preferred stock

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