Question

The Gallagher Corporation has the following capital structure: 50% equity; 45% debt; 5% preferred stock. If the before tax cost of debt is 5% with a tax rate of 32%; a cost of preferred equal to 7.98%; and a cost of retained earnings of 9.2% with a cost of new shares equal to 9.6%. Given this data, what is the WACC for the Gallagher Corporation before exhausting retained earnings and after exhausting retained earnings.

1. 7.28%; 7.36%              b. 6.23%; 6.43%           c. 5.98%; 6.02%           d. 6.53%; 6.73%

Show your calculations here:

Answer 1

> Formula

WACC = Weight of debt * Cost of debt + Weight of Preferred stock * Cost of Preferred stock + Weight of Common stock * Cost of common stock

> Calculation

• Before retained earnings exhausted

Source	Weight	Cost	Product
Debt	45%	5 * ( 1 - 0.32 )	1.53
Preferred Stock	5%	7.98	0.399
Retained earnings	50%	9.2	4.6
			6.53 %

              

• After retained earnings exhausted          

Source	Weight	Cost	Product
Debt	45%	5 * ( 1 - 0.32 )	1.53
Preferred Stock	5%	7.98	0.399
New Equity	50%	9.6	4.8
			6.73 %

Thus correct answer is Option D.

Hope you understand the solution.