Question

The following information comes from the Galaxy Construction balance sheet. The value of common stock is​ $10,000, retained earnings equals​ $7,000, total common equity equals​ $17,000, preferred stock has a value of​ $3,000, and longminusterm debt totals​ $15,000. If the cost of debt is​ 8.00%, preferred stock has a cost of​ 10.00%, common stock has a cost of​ 12.00%, and the firm has a corporate tax rate of​ 30%, calculate the​ firm's WACC adjusted for taxes.A.​10.11%B.​9.09%C.​10.00%D.There is not enough information to answer this question.

Answer 1

Answer:

The WACC is 9.09% and option B is the correct answer.

Explanation:

The WACC or the weighted average cost of capital is a firm's average cost of its capital structure that comprises of debt, preferred stock and common equity. The formula fro WACC is,

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

Where,

• wD, wP and wE represents the weightage of debt, preferred stock and common stock in the capital structure or as a proportion of total assets
• rD, rP and rE represents the cost of debt, preferred stock and common stock
• We take the after tax cost of debt. So, rD is multiplied by (1- tax rate)

Total Assets = 17000 + 3000 + 15000 = 35000

Taking out these values in thousands for simplicity.

WACC = 15/35 * 0.08 * (1-0.3)  +  3/35 * 0.1  +  17/35 * 0.12

WACC = 0.09085 or 9.085% rounded off to 9.09%