Question

P14-9 Calculating WACC [LO3] Mullineaux Corporation has a target capital structure of 60 percent common stock, 5 percent preferred stock, and 35 percent debt. Its cost of equity is 14 percent, the cost of preferred stock is 6 percent, and the cost of debt is 8 percent. The relevant tax rate is 35 percent. (Do not include the percent sign (%). Round your answer to 2 decimal places. (e.g., 32.16)) (a) Mullineaux's WACC is percent. ces (b) Which of the following statement is true? ✓ (Click to select) On an aftertax basis, preferred stock is cheaper than the debt. On an aftertax basis, debt is cheaper than the preferred stock.

Answer 1

(a) Mullineaux’s WACC = 0.60(0.14) + 0.05(0.06) + 0.35(0.08)(1 – 0.35) = 0.1052 or 10.52%

(b) Since interest is tax deductible and dividends are not, we must look at the after-tax cost of debt, which is: 0.08(1 – .35) = 0.0520 or 5.20%

Hence, on an after-tax basis, debt is cheaper than the preferred stock.