Question

Reactive Power Generation has the following capital structure. Its corporate tax rate is 21%. Security Market Value Required Rate of Return Debt $ 20 million 6 % Preferred stock 10 million 8 Common stock 50 million 12 What is its WACC?

Answer 1

Answer:

WACC is 9.69%

Explanation:

The formula for WACC in this scenario is adapted to show preferred stock, hence WACC formula is given below:

WACC=E/V*Ke+P/V*Kp+D/V*Kd*(1-tax)

E implies equity value given as $50 million

P is the preferred stock value which is $10 million

D is the debt value which is $20 million

V is the sum of the finances available to Reactive Power Generation company and it is calculated as $50 million+$20 million +$10 million =$80 million

Ke is the cost of equity of 12%

Kd is the cost of debt 6%

Kp is the cost of preferred stock of 8%

tax rate is 21% or 0.21

WACC=50/80*12%+10/80*8%+20/80*6%*(1-0.21)

WACC=(50/80*12%)+(10/80*8%)+(20/80*4.74% )

WACC=9.69%

Note that I changed cost of debt to after-tax cost of debt before finally computing the WACC.