Question

Turnbull Co. is considering a project that requires an initial investment of $570,000. The firm will raise the $570,000 in capital by issuing $230,000 of debt at a before-tax cost of 9.6%, $20,000 of preferred stock at a cost of 10.7%, and $320,000 of equity at a cost of 13.5%. The firm faces a tax rate of 25%. What will be the WACC for this project

Answer 1

Answer:

WACC = 10.868%

Explanation:

The following data table will show the easiest way to calculate weighted average cost of capital.

Capital components       Investment ($)                Weight                

Debt Capital (Wd)              230,000       230,000 ÷ 570,000 = 0.40

Equity Capital (We)            320,000       320,000 ÷ 570,000 = 0.56

Preference capital (Wp)     20,000          20,000 ÷ 570,000 = 0.04

Total Investment               $570,000                                          1.00

We know,

WACC = [Wd × Kd (1 - T)] + [Wp × kp] + [We × ke]

Given,

Kd (1 - T) = 9.6% × (1 - 0.25) = 7.2%

kp = 10.7%

ke = 13.5%

WACC = [0.40 × 7.2%] + [0.04 × 10.7%] + [0.56 × 13.5%]

or, WACC = 2.88% + 0.428% + 7.56%

Therefore, WACC = 10.868%