Question

Targaryen Corporation has a target capital structure of 70 percent common stock, 5 percent preferred stock, and 25 percent debt. Its cost of equity is 12 percent, the cost of preferred stock is 6 percent, and the pretax cost of debt is 7 percent. The relevant tax rate is 24 percent.
a. What is the company’s WACC? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)


b. What is the aftertax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

Answer:

WACC is 10.03%

After tax cost of debt is 5.32%

Explanation:

It would more appropriate to start with after tax cost of debt as that is required for WACC computation:

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

where t is tax rate of 24% or 0.24

after cost of debt=7%*(1-0.24)=5.32%

WACC=Ke*E/V+Kd(after tax)*D/V+Kp*P/V

Ke is the cost of equity at 12%

Kd(after tax) is the after tax cost of debt at 5.32%

Kp is the cost of preferred stock at 6%

E is the weight of equity at 70%

D is the weight of debt at 25%

P is the weight of preferred stock 5%

V is the total weights of the three which is 100%

WACC=(12%*70/100)+(5.32%*25/100)+(6%*5/100)=10.03%