Question

Peacock Corporation has a target capital structure of 70 percent common stock, 5 percent preferred stock, and 25 percent debt. Its cost of equity is 11 percent, the cost of preferred stock is 5 percent, and the cost of debt is 7 percent. The relevant tax rate is 35 percent.

a.	What is the company’s WACC? (Do not round intermediate calculations. Round the final answer to 2 decimal places.)

WACC

%

   

b.	What is the after-tax cost of debt? (Do not round intermediate calculations. Round the final answer to 2 decimal places.)

Answer 1

Solution:

The formula for calculating the weighted average cost of capital is =

WACC = [ K_e * W_e ] + [ K_p * W_p ] + [ ( K_d * ( 1- t ) ) * W_d ]

K_e = Cost of equity or common stock ; W_e = Weight of equity or common stock;

K_p = Cost of preferred stock ; W_p = Weight of preferred stock ;                            

K_d = Cost of debt  ; t = Income tax rate ; W_d = Weight of debt

As per the information available in the question we have

K_e = 11 %    ; W_e = 70 % = 0.70 ;   K_p = 5 %   ; W_p = 5 % = 0.05 ;         t = 35 % = 0.35   ; K_d = 7 %    ; W_d = 25 % = 0.25

Applying the above values in the formula we have

= [ 11 * 0.70 ] + [ 5 *0.05 ] + [ 7 * ( 1 – 0.35 ) * 0.25 ]

= 7.7 + 0.25 + ( 4.55 * 0.25 )

= 7.7 + 0.25 + 1.1375

= 9.0875

Thus the company’s WACC is = 9.0875 %

= 9.09 % ( when rounded off to two decimal places )

Calculation of after tax cost of debt:

After tax cost of debt = K_d * ( 1- t )

As per the information given in the question we have

K_d = 7 %   ;        t = 35 % = 0.35

= 7 * ( 1 -0.35 ) = 7 * 0.65 = 4.55 %

Thus the after tax cost of debt = 4.55 %

Thus solution to question a = Company's WACC = 9.09 %

Thus solution to question b = After tax cost of debt = 4.55 %