Question

CENGAGE MINDTAP Q Search this course Ch 10: End-of-Chapter Problems - The Cost of Capital ох Attempts: Keep the Highest: /1 9. Problem 10.09 Click here to read the eBook: An Overview of the Weighted Average Cost of Capital (WACC) Click here to read the eBook: Basic Definitions WACC The Pawlson Company's year-end balance sheet is shown below. Its cost of common equity is 14%, its before-tax cost of debt is 10%, a marginal tax rate is 40%. Assume that the firm's long-term debt sells at par value. The firm's total debt, which is the sum of the company's short-term de and long- term debt, equals $1,194. The firm has 576 shares of common stock outstanding that sell for $4.00 per share. Assets Cash $ 120 Accounts receivable 240 Liabilities And Equity Accounts payable and ACCOU accruals Short-term debt Long-term debt 1,130 Common equity 1,676 Total liabilities and $2,880 equity Inventories 360 Plant and equipment, net 2,160 Total assets $2,880 Calculate Pawson's WACC using market value weights, Round your answer to two decimal places. Do not round your intermediate calculations. Core with 113 Power e and...litic

Answer 1

Given,

Cost of Equity (K_e)= 14% =0.14

Before tax cost of Debt (K_d)= 10% = 0.1

Marginal Tax rate (t) = 40% = 0.4

The firm's long term debt sells at par value , thus the market value of long term debt is 1130

Also, the total debt (D) of the firm = 1194

The firm has 576 shares of common stock selling at $4.0 per share

Therefore, market value of equity (E) = 576 *4 = $2,304

Therefore , Weight of Debt (W_d) = 1194/(1194+2304) = 0.3413379

and Weight of Equity (W_e) = 2304/(1194+2304) = 0.6586621

And Hence, the WACC can be calculated which is given as

WACC = W_d *K_d *(1-t) + W_e *K_e

WACC = 1194/3498*0.1*(1-0.4) + 2304/3498 * 0.14

= 0.020480+0.092212

= 0.112692 = 11.27%