Question

Targaryen Corporation has a target capital structure of 75 percent common stock, 10 percent preferred stock, and 15 percent debt. Its cost of equity is 9 percent, the cost of preferred stock is 5 percent, and the pretax cost of debt is 6 percent. The relevant tax rate is 21 percent.a. What is the company’s WACC? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)b. What is the aftertax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

Answer:

a.

WACC = 0.07961 or 7.961% rounded off to 7.96%

b.

After tax cost of debt = 0.0474 or 4.74%

Explanation:

a.

The weighted average cost of capital or WACC is the cost of a firm's capital structure. To calculate the WACC, we multiply the weight of each component of the capital structure by the cost of that component. The components of capital structure can be one or all of the following namely 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

• r represents the cost of each component

• D, P and E represents debt, preferred stock and common stock respectively

WACC = 0.15 * 0.06 * (1 - 0.21)  +  0.1 * 0.05  +  0.75 * 0.09

WACC = 0.07961 or 7.961% rounded off to 7.96%

b.

The after tax cost of debt is calculated by multiplying the cost of debt by (1 - tax rate) to adjust for the tax advantage provided by debt as interest payments on debt are tax deductible.

After tax cost of debt = 0.06 * (1 - 0.21)

After tax cost of debt = 0.0474 or 4.74%