Reference no: EM132688915

The following data is regarding the Link Company:•A target weight of debt to total capital of 28.57%

• Bonds with similar risk are currently yielding 8%
• Link is a constant growth firm that just paid a dividend of $4.00
• The stock sells for $33 per share, and has an expected growth rate of 4%
• The Marginal tax rate is 20%

What is Link's after-tax cost of capital?

Answer:

Use the revised form of the constant growth model to determine the cost of equity. Use algebra to determine the weights for the target capital structure realizing that debt is 40% of equity. Substitute 0.4E for D in the formula below.

Ke = (D0(1+g)÷P0) = (4)(1.04) ÷ (33) + 0.04 = 16.6%

V = debt + equity = 0.4 + 1 = 1.4

WACC = (E÷V)(Ke ) + (D ÷ V)(Kd)(1 - t) 

WACC = 0.7143(0.166) + 0.2857(0.08)(1 - 0.2) = 0.1186 + 0.0183 = 13.69%

My Questions are:

1. What the purpose of this equation V = debt + equity = 0.4 + 1 = 1.4
2. How did they realize that debt is 40% of equity
3. From where did they got 0.7143 in WACC (underlined)
4. Why did they use this equation Ke = (D0(1+g)÷P0) + growth not this one Ke = D1÷P0 + growth