Question

The CFO of Polar Bear, Inc. has set the targets for the company's capital structure to be the following: 65 percent common stock, 10 percent preferred stock, and 25 percent debt. Its cost of equity is 9 percent, the cost of preferred stock is 4 percent, and the pretax cost of debt is 5 percent. The relevant tax rate is 21 percent.

What is the company’s WACC? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
b. What is the aftertax cost of debt?

Answer 1

The WACC is computed as shown below:

= cost of common stock x weight of common stock + cost of preferred stock x weight of preferred stock + pretax cost of debt (1 - tax rate) x weight of debt

= 0.09 x 0.65 + 0.04 x 0.10 + 0.05 (1 - 0.21) x 0.25

= 0.0585 + 0.004 + 0.009875

= 7.24% Approximately

b. The after tax cost of debt is computed as shown below:

= Pretax cost of debt (1 - tax rate)

= 0.05 (1 - 0.21)

= 3.95%

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