Question

Clark? Explorers, Inc., an engineering? firm, has the following capital? structure:

Numbers in order of: Equity, Preferred Stock, Debt
Market Price: $63.06 $107.29 $1064.54
Outstanding units: 127,000 11,000 6,868
Book value: $2,734,000   $1,182,000 $6,868,000
Cost of capital: 18.04% 12.68% 10.8%

Using market value and book value? (separately, of? course), find the adjusted WACC for Clark Explorers at the following tax? rates:

A. 35%

B. 25%

C. 15%

D. 10%

Answer 1

WACC = weight of equity * cost of equity + weigth of preferred stock * cost of preferred stock + weight of debt * cost of debt

WACC on the basis of book value

Total book value = 2,734,000 + 1,182,000 + 6,868,000 = $10,784,000

Weigth of equity = 2,734,000 / 10,784,000 = 0.2535

Weight of preferred stock = 1,182,000 / 10,784,000 = 0.1096

Weight of debt = 6,868,000 / 10,784,000 = 0.6369

When tax rate is 35%:

WACC = 0.2535 * 0.1804 + 0.1096 * 0.1268 + 0.6369 * 0.108 ( 1 - 0.35)

WACC = 0.045731 + 0.013897 + 0.04471

WACC = 0.10434 or 10.434%

When tax rate is 25%:

WACC = 0.2535 * 0.1804 + 0.1096 * 0.1268 + 0.6369 * 0.108 ( 1 - 0.25)

WACC = 0.045731 + 0.013897 + 0.051589

WACC = 0.11122 or 11.122%

When tax rate is 15%:

WACC = 0.2535 * 0.1804 + 0.1096 * 0.1268 + 0.6369 * 0.108 ( 1 - 0.15)

WACC = 0.045731 + 0.013897 + 0.058467

WACC = 0.1181 or 11.81%

When tax rate is 10%:

WACC = 0.2535 * 0.1804 + 0.1096 * 0.1268 + 0.6369 * 0.108 ( 1 - 0.1)

WACC = 0.045731 + 0.013897 + 0.06191

WACC = 0.1215 or 12.15%

WACC on the basis of market value

Total book value = (127,000 * 63.06) + (11,000 * 107.29) + (  6,868 * 1064.54)

Total book value = 8,008,620 + 1,180,190 + 7,311,260.72 = 16,500,070.72

Weigth of equity = 8,008,620 / 16,500,070.72 = 0.4854

Weight of preferred stock = 1,180,190 / 16,500,070.72 = 0.0715

Weight of debt = 7,311,260.72 / 16,500,070.72 = 0.4431

When tax rate is 35%:

WACC = 0.4854 * 0.1804 + 0.0715 * 0.1268 + 0.4431 * 0.108 ( 1 - 0.35)

WACC = 0.08757 + 0.00907 + 0.03111

WACC = 0.12775 or 12.775%

When tax rate is 25%:

WACC = 0.4854 * 0.1804 + 0.0715 * 0.1268 + 0.4431 * 0.108 ( 1 - 0.25)

WACC = 0.08757 + 0.00907 + 0.03589

WACC = 0.1325 or 13.25%

When tax rate is 15%:

WACC = 0.4854 * 0.1804 + 0.0715 * 0.1268 + 0.4431 * 0.108 ( 1 - 0.15)

WACC = 0.08757 + 0.00907 + 0.040677

WACC = 0.1373 or 13.73%

When tax rate is 10%:

WACC = 0.4854 * 0.1804 + 0.0715 * 0.1268 + 0.4431 * 0.108 ( 1 - 0.1)

WACC = 0.08757 + 0.00907 + 0.04307

WACC = 0.1397 or 13.97%