Allen, Inc. is initially 100% equity-financed; Allen earned $10 million for the fiscal year ending yesterday. The firm also paid out 25% of its earnings as dividends yesterday. Assume the firm will continue to pay out 25% of its earnings as annual end-of-year dividends forever. The remaining 75% of earnings is retained by the company for use in projects. The company has 1.25 million shares of common stock outstanding. The current stock price is $40/share. The historical return on equity of 11% is expected to continue in the future.
- What is the required rate of return on the stock? (12 marks)
- Allen, Inc. plans to change its capital structure that it will issue 5 million of perpetual debt. The bonds will sell at par with a 6% annual coupon rate (the bonds make annual coupon payments). Assume Allen will remain the new capital structure indefinitely. And Allen is subject to a corporate tax rate of 40%. Compute the cost of debt for Allen, Inc. ? (2 marks)
- What is the WACC for Allen, Inc.? (6 marks)
