Question

Baron Corporation has a target capital structure of 65 percent common stock, 10 percent preferred stock, and 25 percent debt. Its cost of equity is 9 percent, the cost of preferred stock is 4 percent, and the pretax cost of debt is 5 percent. The relevant tax rate is 21 percent.
a. What is the company’s WACC?
b. What is the aftertax cost of debt?

Answer 1

Answer:

WACC is 7.24%

After tax cost of debt is 3.95%

Explanation:

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

Ke is the cost of equity of 9% or 0.09

Kd  is the cost of debt at 5% or 0.05

Kp is the of preferred stock of 4% or 0.04

E is the weight of equity of 65% 0r 0.65

D is the weight of debt of 25% 0.25

K is the weight of preferred stock of 10% or 0.10

t is the tax rate of 21% or 0.21

WACC=(0.09*0.65)+(0.05*0.25*1-0.21)+(0.04*0.10)

WACC=(0.09*0.65)+(0.05*0.25*0.79)+(0.04*0.10)

WACC=7.24%

after tax cost of debt=pretax cost of debt*(1-t)

                                  =0.05*(1-0.21)

                                 =0.0395=3.95%