Question

Sheridan Co. has a capital structure, based on current market values, that consists of 45 percent debt, 6 percent preferred stock, and 49 percent common stock. If the returns required by investors are 8 percent, 10 percent, and 15 percent for the debt, preferred stock, and common stock, respectively, what is Sheridan’s after-tax WACC? Assume that the firm’s marginal tax rate is 40 percent. (Round final answer to 2 decimal places, e.g. 15.25%.)

After-Tax WACC = ?%

Answer 1

Solution:

The formula for calculating the after tax weighted average cost of capital ( WACC ) is =

After tax WACC = [ K_c * W_c ] + [ K_p * W_p ] + [ ( K_d * ( 1 – t ) ) * W_d ]

where

K_c = Cost of Common stock ;    W_c = Weight of Common Stock   ;

K_p = Cost of Preferred Stock ; W_p = Weight of Preferred stock    ;  

K_d = Pre tax cost of debt    ; W_d = Weight of debt ;   t = Tax rate   ;

As per the information available in the question we have

K_c = 15 %    ;    W_c = 49 % = 0.49 ; K_p = 10 % ;    W_p = 6 % = 0.06     ;

K_d = 8 %     ;    W_d = 45 % = 0.45 ;     t = 40 % = 0.40 ;

Applying the above values in the formula we have

= [ 15 % * 0.49 ] + [ 10 % * 0.06 ] + [ ( 8 % * ( 1 – 0.40 ) ) * 0.45 ]

= 7.35 % + 0.6 % + ( 8 % * 0.60 * 0.45 )

= 7.35 % + 0.6 % + 2.16 %

= 10.1100 %

= 10.11 % ( when rounded off to two decimal places )

Thus Sheridan's after tax ( WACC ) is 10.11 %