Question

Blossom Co. has a capital structure, based on current market values, that consists of 30 percent debt, 3 percent preferred stock, and 67 percent common stock. If the returns required by investors are 10 percent, 13 percent, and 15 percent for the debt, preferred stock, and common stock, respectively, what is Blossom’s after-tax WACC? Assume that the firm’s marginal tax rate is 40 percent.

Answer 1

Answer:

The WACC is 12.24%

Explanation:

The WACC or weighted average cost of capital is the cost of a firm's capital structure. The capital structure can be comprised of three components which are debt, preferred stock and common stock.

The formula for WACC is,

WACC = wD * rD * (1-tax rate)  +  wP * rP  +  wE * rE

Where,

• w represents the weight of each component in the capital structure

• r represents the cost of each component

• We take the after tax cost of debt. Thus we multiply the cost of debt by (1 - tax rate)

WACC = 0.3 * 0.10 * (1 - 0.4)  +  0.03 * 0.13  +  0.67 * 0.15

WACC =0.1224 or 12.24%