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The Gordon Growth Model, also known as the Dividend Discount Model, is a well-known method for valuing a company's stock price based on its future series of dividends that are expected to grow at a constant rate. It's a preferred approach because of its simplicity and logical reasoning. This model helps in calculating the Cost of Common Equity, an important factor of WACC.
The formula for the Gordon Growth Model is:

• \(k_e = \frac{D_1}{P_0} + g\)
  • \(k_e\) is the cost of common equity.
  • \(D_1\) is the expected next year's dividend. It can be calculated by \(D_1 = D_0 \times (1 + g)\), where \(D_0\) is the last dividend paid, and \(g\) is the growth rate.
  • \(P_0\) is the current stock price.
  • \(g\) is the constant growth rate of dividends.

Using this model, investors can assess whether a stock is overvalued or undervalued relative to its intrinsic value. By plugging in the values from the original exercise, one can determine the expected return on equity, helping in making informed investment decisions.

The Cost of Common Equity is a reflection of what investors expect to earn from investing in a company's stock. This expectation not only focuses on dividends but also includes the potential appreciation in the stock's value. In other words, it's the return an investor requires from an investment in equity.
Here’s how the Gordon Growth Model aids in computing this metric:

• First, calculate the expected dividend for the next year \(D_1\) using the growth rate and the latest dividend payout.
• Then, divide \(D_1\) by the current stock price \(P_0\).
• Add the constant growth rate \(g\) to this result to determine \(k_e\), the Cost of Common Equity.

This rate represents the opportunity cost for investors if they choose to hold the particular stock instead of seeking alternative investments with similar risk profiles.
In our original exercise case, we found that the Cost of Common Equity is 16.51%, revealing the high return rate required by investors and aiding corporations in capital budgeting decisions.

The After-Tax Cost of Debt for a company is the interest rate after accounting for the tax deductions that come from interest payments. Since interest payments are tax-deductible, the after-tax cost of debt is usually lower than the face or nominal interest rate.
To calculate it:

• Determine the before-tax cost of debt \(r_d\) which is the interest rate the company pays on its debt, unadjusted for taxes.
• Multiply \(r_d\) by \((1 - T)\), where \(T\) represents the corporate tax rate.

This gives you the after-tax rate that reflects the actual cost to the company after factoring in the tax benefits they receive from the debt. In our explanation, this cost is calculated as 7.2% for the given exercise.
This is a critical component of WACC, helping to ensure the accurate calculation of the company’s minimum return needed on its investments. Recognizing this cost helps businesses in efficient financial planning by comparing different funding options.