Peacock Corporation has a target capital structure of 70 percent common stock, 5 percent preferred stock, and 25 percent debt. Its cost of equity is 11 percent, the cost of preferred stock is 5 percent, and the cost of debt is 7 percent. The relevant tax rate is 35 percent. |
a. |
What is the company’s WACC? (Do not round intermediate calculations. Round the final answer to 2 decimal places.) |
WACC | % |
b. |
What is the after-tax cost of debt? (Do not round intermediate calculations. Round the final answer to 2 decimal places.) |
Solution:
The formula for calculating the weighted average cost of capital is =
WACC = [ Ke * We ] + [ Kp * Wp ] + [ ( Kd * ( 1- t ) ) * Wd ]
Ke = Cost of equity or common stock ; We = Weight of equity or common stock;
Kp = Cost of preferred stock ; Wp = Weight of preferred stock ;
Kd = Cost of debt ; t = Income tax rate ; Wd = Weight of debt
As per the information available in the question we have
Ke = 11 % ; We = 70 % = 0.70 ; Kp = 5 % ; Wp = 5 % = 0.05 ; t = 35 % = 0.35 ; Kd = 7 % ; Wd = 25 % = 0.25
Applying the above values in the formula we have
= [ 11 * 0.70 ] + [ 5 *0.05 ] + [ 7 * ( 1 – 0.35 ) * 0.25 ]
= 7.7 + 0.25 + ( 4.55 * 0.25 )
= 7.7 + 0.25 + 1.1375
= 9.0875
Thus the company’s WACC is = 9.0875 %
= 9.09 % ( when rounded off to two decimal places )
Calculation of after tax cost of debt:
After tax cost of debt = Kd * ( 1- t )
As per the information given in the question we have
Kd = 7 % ; t = 35 % = 0.35
= 7 * ( 1 -0.35 ) = 7 * 0.65 = 4.55 %
Thus the after tax cost of debt = 4.55 %
Thus solution to question a = Company's WACC = 9.09 %
Thus solution to question b = After tax cost of debt = 4.55 %
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