Question

Reactive Power Generation has the following capital structure. Its corporate tax rate is 35%.

What is the companys WACC? Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.

Security	Market Value	Required Rate of Return
Debt	30 million	6%
Preferred stock	30 million	8%
Common stock	40 million	12%

Answer 1

Weighted Average Cost of Capital (WACC)

The Weighted Average Cost of Capital (WACC) is calculated by using the following formula

Weighted Average Cost of Capital (WACC) = [After Tax Cost of Debt x Weight of Debt] + [Cost of Preferred stock x Weight of preferred stock] + [Cost of equity x Weight of Equity]

After Tax Cost of Debt = 3.90% [6.00% x (1 – 0.35)]

Cost of Preferred stock = 8.00%

Cost of equity = 12.00%

Total Market Value = $100 Million [$30 Million + $30 Million + $40 Million]

Weight of Debt = 0.30 [$30 Million / $100 Million]

Weight of Preferred Stock = 0.30 [$30 Million / $100 Million]

Weight of Equity = 0.40 [$40 Million / $100 Million]

Therefore, the Weighted Average Cost of Capital (WACC) = [After Tax Cost of Debt x Weight of Debt] + [Cost of Preferred stock x Weight of preferred stock] + [Cost of equity x Weight of Equity]

= [3.90% x 0.30] + [8.00% x 0.30] + [12.00% x 0.40]

= 1.17% + 2.40% + 4.80%

= 8.37%

“Hence, the Company’s Weighted Average Cost of Capital (WACC) will be 8.37%”