Weighted average cost of capital (WACC)

User Generated

yrfyvrpnthva

Business Finance

Description

Given the following information on Big Brothers, Inc. capital structure, compute the company’s weighted average cost of capital (WACC). The company’s marginal tax rate is 40%.

Round the answer to two decimal places in percentage form. 

Type of CapitalPercent of Capital StructureBefore-Tax Component Cost
Bonds41%13.46%
Preferred Stock14%15.89%
Common StockPlease calculate it17.73%

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Explanation & Answer

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Answer:

Formula for calculating WACC:

WACC = (Weight of Equity X Cost of Equity) + (Weight of Preferred Stock X 

 Cost of Preferred Stock) + [Weight of debt X Cost of Debt (1 - Tax)]

Here we substitute the values as per the question :-

Weight of Equity = 45% = 0.45

Cost of Equity = 17.73% = 0.1773

Weight of Preferred Stock = 14% = 0.14

Cost of Preferred Stock = 15.89% = 0.098

Weight of debt = 41% = 0.41

Cost of Debt = 13.46% = 0.1346

1 - Tax = 1 - 40 = 60% = 0.60

WACC = (Weight of Equity X Cost of Equity) + (Weight of Preferred Stock X 

 Cost of Preferred Stock) + [Weight of debt X Cost of Debt (1 - Tax)]

WACC = (0.45 X 0.1773) + (0.14 X 0.1589) + (0.41 X 0.1346 X 0.60)

 = 0.08 + 0.02 + 0.03

 = 0.13

 = 13 %

Therefore Big Brothers, Inc.  WACC is = 13 %.


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