Question

Turnbull Co. has a target capital structure of 58% debt, 6% preferred stock, and 36% common equity. It has a before-tax cost of debt of 8.2%, and its cost of preferred stock is 9.3%. If Turnbull can raise all of its equity capital from retained earnings, its cost of common equity will be 12.4%. However, if it is necessary to raise new common equity, it will carry a cost of 14.2%, 0.83%, 0.86%, 0.64%, and 0.70%. 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 8.7%, $78,000 of preferred stock at a cost of 9.9%, and $880,000 of equity at a cost of 13.2%. The firm faces a tax rate of 40%. what will be the WACC for this project?

Answer 1

Answer:

9.55%

Explanation:

WACC for the project=We*Ke+Wp*Kp+Wd*Kd*(1-tax rate)

We=weight of equity=equity value/total cost of the project=$880,000/$1,708,000=51.52%

Wp=weight of preferred stock=preferred stock value/total cost of the project=$78,000/$1,708,000=4.57%

Wd=weight of debt=value of debt/total cost of the project=$750,000/$1,708,000=43.91%

Ke=cost of equity=13.2%

Kp=cost of preferred stock=9.9%

Kd=cost of debt=8.7%

tax rate=40%

WACC for the project=(51.52% *13.2%)+(4.57% *9.9%)+(43.91% *8.7%)*(1-40%)=9.55%