Question

	You were hired as a consultant to Quigley Company, whose target capital structure is 35% debt, 10% preferred, and 55% common equity. The interest rate on new debt is 6.50%, the yield on the preferred is 6.00%, the cost of retained earnings is 11.25%, and the tax rate is 40%. The firm will not be issuing any new stock. What is Quigley's WACC (I would like the explanation)
	Selected Answer: 8.15% Answers: 8.15% 9.17% 8.48% 8.82%

Answer 1

Weighted average cost of capital (WACC) is the sum product of weight of capital in the capital structure and its cost.

where,

wd = Weight of Debt

kd = After-tax cost of debt^#

wp = Weight of preferred stock

kp = Cost of preferred stock

we = Weight of common equity

ke = Cost of common equity ( here, retained earnings)

^#Interest payments on Debt are tax deductible thus we use after-tax cost of debt in WACC calculation.

Cost of Debt = 6.50%

Tax rate = 40%

After-tax Cost of Debt = 6.50%*(1-40%) = 3.90%

Now, Put values in formula to calculate WACC

Hope it will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.