Question

Wildhorse Co. has a capital structure, based on current market values, that consists of 35 percent debt, 8 percent preferred stock, and 57 percent common stock. If the returns required by investors are 12 percent, 12 percent, and 15 percent for the debt, preferred stock, and common stock, respectively, what is Wildhorse’s after-tax WACC? Assume that the firm’s marginal tax rate is 40 percent

Answer 1

Solution:

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

WACC = [ K_D * ( 1 – t ) * W_D ] + [ K_P * W_P ] + [ K_C * W_C ]

K_D = Required rate of return of debt    ; t = Income tax rate ; W_D = Weight of debt ;

K_P = Required rate of return of Preferred Stock ; W_P = Weight of preferred stock    ;  

K_C = Required rate of return of Common Stock     ;    W_C = Weight of common stock

As per the information available in the question we have

K_D = 12 %     ; t = 40 % = 0.40 ; W_D = 0.35 ; K_P = 12 % ;    W_P = 0.08     ;   K_C = 15 %    ;    W_C = 0.57

Applying the above values in the formula we have

= [ ( 12 * ( 1 – 0.40 ) * 0.35 ) + ( 12 * 0.08 ) + ( 15 * 0.57 ) ]

= [ ( 12 * 0.60 * 0.35 ) + 0.96 + 8.55 ]

= 2.52 + 0.96 + 8.55

= 12.03

Thus the after tax weighted average cost of capital of Wild horse co. is 12.03 %