Question

Turnbull Co. is considering a project that requires an initial investment of $1,708,000. The firm will raise the $1,708,000 in capital by issuing $750,000 of debt at a before-tax cost of 9.6%, $78,000 of preferred stock at a cost of 10.7%, and $880,000 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:

The WACC for this project is 10.605%

Explanation:

The WACC or the weighted average cost of capital is the weighted average return that the company is expected to pay its capital providers.The WACC is calculated by multiplying the cost of each component by their respective weights in the capital structure. The WACC is calculated using the following formula,

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

Where,

• wD, wP and wE represents the weight of debt, preferred stock and common equity respectively as a proportion of total capital.
• rD, rP and rE is the cost of debt, preferred stock and equity respectively.
• The (1-tax) is used in debt component to calculate the after tax cost of debt

WACC = 750000/1708000 * (1-0.25) * 0.096  +  78000/1708000 * 0.107  +  880000/1708000 * 0.135

WACC =  0.10605 or 10.605%