Question

Shi Import-Export's balance sheet shows $300 million in debt, $50 million in preferred stock, and $250 million in total common equity. Shi's tax rate is 30%, r_d = 6%, r_ps = 7.9%, and r_s = 10%. If Shi has a target capital structure of 30% debt, 5% preferred stock, and 65% common stock, what is its WACC? Round your answer to two decimal places.

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After-Tax Cost of Debt

LL Incorporated's currently outstanding 11% coupon bonds have a yield to maturity of 14%. LL believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 30%, what is LL's after-tax cost of debt? Round your answer to two decimal places.

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Answer 1

The weighted average cost of capital is calculated using the below formula:

WACC=Wd*Kd(1-t)+Wps*Kps+We*Ke

where:

Wd= Percentage of debt in the capital structure.

Kd= The before tax cost of debt

Wps= Percentage of preferred stock in the capital structure

Kps=Cost of preferred stock

We=Percentage of equity in the capital structure

Ke= The cost of common equity.

T= Tax rate

WACC= 0.30*6%*(1 – 0.30) + 0.05*7.9% + 0.65*10%

            = 0.30*4.20% + 0.05*7.9% + 0.65*10%

            = 1.26% + 0.3950% + 6.50%

           = 8.1550%     8.16%.

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Information provided:

Yield to maturity= 14%

Tax rate= 30%

After tax cost of debt= before tax cost of debt*(1 – tax rate)

                                        = 14%*(1 – 0.30)

                                        = 9.80%.

In case of any query, kindly comment on the solution