Question

Baron Corporation has a target capital structure of 70 percent common stock, 5 percent preferred stock, and 25 percent debt. Its cost of equity is 10 percent, the cost of preferred stock is 6 percent, and the pretax cost of debt is 7 percent. The relevant tax rate is 22 percent. a. What is the company’s WACC? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) b. What is the aftertax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

1. What is the company’s WACC? =8.67%

Formula for calculating WACC = Kd * Wd + Ke * We + Kp * Wp

Kd = after tax cost of debt

Wd = Weight of Debt

Ke = Cost of Equity

We = Weight of Equity

Kp = Cost of Preference shares

Wp = Weight of Preference Shares

Calculation of total Capital and Weight of each component

Security	Cost	Cost Denoted by	Weight	Weight Denoted By
(I)	(II)		(III)	(IV)
Common stock	10%	Ke	70%	We
Preferred stock	6%	Kp	5%	Wp
Debt	5.46% (After tax, See part B answer)	Kd	25%	Wd

WACC = Kd * Wd + Ke * We + Kp * Wp

          =5.46% x 25% + 6% x 5% + 10% * 70%

          =8.67%

2. What is the after-tax cost of debt?

Formula for calculating after tax cost of Debt = Interest rate * (1 – Tax Rate)

                                                                                    =7% * (1 – 22%)

                                                                                    = 7% * 78%

                                                                                    =5.46%