Question

ABC Corporation operates as a retailer in North America and internationally. The Company serves customers through retail sites such as ABC.com which primarily includes merchandise and content purchased for resale from vendors and those offered by thrid party sellers. Assume that ABC corp. has the following capital structure:

Debt = $20,000,000

Preferred Stock=   $10,000,000

Equity (C/S)= $ 70,000,000

Total Capital Venture of Firm $100,000,000

Assume that the required rate of return on equity is 14.8% ABCs debt is currently yielding 10% and its preferred stock is yielding 10.66% ABC Corp has a 34% marginal Tax Rate

Compute ABCs Weighted Average Cost of Capital (WACC) (as a %)

Answer 1

WACC or Weighted average cost of capital = Weight of Equity * Cost of equity + Weight of debt * After tax Cost of debt + Weight of preferred stock * Cost of preferred stock

Weight of Equity = (Market value of Equity/Total Capital Venture of Firm) * 100 = (70,000,000/100,000,000)*100 = 70%

Weight of debt = (Market value of Debt/Total Capital Venture of Firm) * 100 =  (20,000,000/100,000,000)*100 = 20%

Weight of preferred stock = (Market value of preferred stock/Total Capital Venture of Firm) * 100 = (10,000,000/100,000,000) * 100 = 10%

After tax cost of debt = Pre tax cost of debt * (1-T) = 10% * (1-0.34) = 6.6%

ABC's WACC = Weight of Equity * Cost of equity + Weight of debt * After tax Cost of debt + Weight of preferred stock * Cost of preferred stock = 70% * 14.8% + 20% * 6.6% + 10% * 10.66% = 12.75%