Palencia Paints Corporation has a target capital structure of 35% debt and 65% common equity, with no preferred stock. Its before-tax cost of debt is 10%, and its marginal tax rate is 25%. The current stock price is P0 = $26.00. The last dividend was D0 = $2.75, and it is expected to grow at a 5% constant rate. What is its cost of common equity and its WACC? Do not round intermediate calculations. Round your answers to two decimal places.

The constant growth model of DDM is used to value stock paying a dividend which is growing at a constant rate. The formula for price today of such a stock is,

P0 = D0 * (1+g)/ r - g

Where,

D0 is dividend today
r is the required rate of return or cost of equity
g is the constant growth rate

By plugging in the values of P0, D0 and g in the formula we can calculate r,

26 = 2.75 * (1+0.05) / (r - 0.05)

26 * (r - 0.05) = 2.8875

26r - 1.3 = 2.8875

26r = 2.8875 + 1.3

r = 4.1875 / 26

r = 0.1610576923 or 16.10576923% rounded off to 16.11%

Cost of common equity is 16.11%

The WACC or weighted average cost of capital is the cost of a firm's capital structure. The capital structure contains at least one of at most all of the following components namely debt, preferred stock and common equity.

The WACC for a company having only debt and common equity is calculated as follows,

WACC = wD * rD * (1 - tax rate) + wE * rE

Where,

wD, wE represents the weight of debt and equity
rD, rE represents the cost of debt and equity
We take the after tax cost of debt so we multiply the cost of debt by (1 - tax rate)

WACC = 0.35 * 0.1 * (1 - 0.25) + 0.65 * 0.1610576923

WACC = 0.1309375 or 13.09375% rounded off to 13.09%