Question

Mullineaux Corporation has a target capital structure of 70 percent common stock, 15 percent preferred stock, and 15 percent debt. Its cost of equity is 12 percent, the cost of preferred stock is 4 percent, and the pretax cost of debt is 5 percent. The relevant tax rate is 35 percent. a. What is the company’s WACC?b. What is the aftertax cost of debt?

Answer 1

Answer:

a.

The WACC is 9.4875%

b.

The after tax cost of debt is 3.25%

Explanation:

The WACC or Weighted average cost of capital is the cost to a firm of its capital structure based on the weighted average of costs of all the components that form up its capital structure. The components in a firm's capital structure are debt, preferred stock and common stock.

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

Where,

• w represents the weight of each component in the overall capital structure
• r represents the cost of each component
• we multiply the cost of debt by (1 - tax rate) to take the after tax cost of debt

a.

WACC = 0.15 * 0.05 * (1-0.35)  +  0.15 * 0.04  +  0.7 * 0.12

WACC = 0.094875 or 9.4875%

b.

The after tax cost of debt is calculated by multiplying the cost of debt or rD by (1 - tax rate).

After tax cost of debt = 0.05 * (1 - 0.35)    =  0.0325 or 3.25%