Question

Blender Corporation has 1,000 bonds outstanding, each selling for S2600 with a required rate of return of 6%. Blender has 5,000 shares of preferred stock outstanding, selling for $30 per share and 50,000 shares of common stock outstanding, selling for $14 per share. If the preferred stock has a required rate fo return of 10% and the common stock requires a 20% return, and the firm has a corporate tax rate of 25%, calculate the WACC adjusted for taxes. O 66% 11.4% O 7.9% O 5.5% 9.5%

Answer 1

Market Value of Debt = $26,00,000 [1,000 Bonds x $2,600 per Bond]

Market Value of Preferred Stock = $150,000 [5,000 Shares x $30]

Market Value of Equity = $700,000 [50,000 Shares x $14]

Total Market Value = $34,50,000

Weight of Debt = 0.7536 [$26,00,000 / $34,50,000]

Weight of Preferred Stock = 0.0435 [$150,000 / $34,50,000]

Weight of Equity = 0.2029 [$700,000 / $34,50,000]

After-Tax Cost of Debt

After-Tax Cost of Debt = Required Return on Bond x (1 – Tax Rate)

= 6.00% x (1 – 0.25)

= 6.00% x 0.75

= 4.50%

Cost of Preferred Stock = 10.00%

Cost of Equity = 20.00%

Weighted Average Cost of Capital (WACC) adjusted for taxes

Weighted Average Cost of Capital (WACC) = [After-tax cost of debt x Weight of Debt] + [Cost of Preferred stock x Weight of Preferred stock] + [Cost of equity x Weight of Equity]

= [4.50% x 0.7536] + [10.00% x 0.0435] + [20.00% x 0.2029]

= 3.4% + 0.4% + 4.1%

= 7.9%

“Hence, the Weighted Average Cost of Capital (WACC) adjusted for taxes would be 7.9%”