Question

Mullineaux Corporation has a target capital structure of 70 percent common stock and 30 percent debt. Its cost of equity is 16 percent, and the cost of debt is 8 percent. The relevant tax rate is 30 percent.
(a) What is Mullineaux’s WACC?
(b) The company president has approached you about Mullineaux’s Capital structures. He wants to know why the company doesn’t use more preferred stock financing, since it costs less than debt. What would you tell the president?

Answer 1

Answer and Explanation:

a. The computation of the wacc is as followS;

= cost of common stock × weight of common stock + cost of debt × weight of debt × (1 - tax rate)

= 0.16 × 0.70 + 0.08 × 0.30 × (1 - 0.30)

= 0.112 + 0.0168

= 0.1288

= 12.88%

b. The after tax cost of debt is

= 0.08 × (1- 0.30)

= 0.056

So the capital should use the cost of debt