Question

The company has the following capital structure requirements for the raising of new capital for any new projects the company is undertaking next year. The firm has a corporate tax rate of 40%. What is the weighted average cost of capital?

Answer 1

The common stock and preferred stock dividend are not tax deductible and thus cost considered should be before tax
Calculation of before tax cost of preferred stock
Before tax cost of preferred stock	10%/(1-0.40)
Before tax cost of preferred stock	16.67%
Calculation of before tax cost of common stock equity
Before tax cost of equity	13%/(1-0.40)
Before tax cost of equity	21.67%
Weighted average cost of capital	Cost of equity*Weight of equity + Cost of preferred stock*Weight of preferred stock + Cost of debt*Weight of debt
Weighted average cost of capital	(0.2167*40%)+(0.1667*0.20)+(0.06*0.40)
Weighted average cost of capital	14.40%
Thus, weighted average cost of capital is 14.40%.