Question

Targaryen Corporation has a target capital structure of 70 percent common stock, 5 percent preferred stock, and 25 percent debt. Its cost of equity is 10 percent, the cost of preferred stock is 6 percent, and the pretax cost of debt is 7 percent. The relevant tax rate is 22 percent.

What is the company's WACC?

What is the aftertax cost of debt?

Answer 1

WACC=Percentage of equity*Cost of equity + Percentage of debt*Pretax cost of debt*(1-Tax Rate)+Percentage of preferred stock*Cost of preferred stock
Percentage of equity=70%
Cost of equity=10%
Percentage of preferred stock=5%
Cost of preferred stock=6%
Percentage of debt=25%
Pretax cost of debt=7%
Tax rate=22%

Part 1:

Weighted average cost of capital or WACC is calculated as:
WACC=70%*10%+25%*7%*(1-22%)+5%*6%
=0.07+0.0175*(0.78)+0.003
=0.07+0.01365+0.003
=0.08665 or 8.67% (Rounded to two decimal places)

Part 2:

After tax cost of debt=Pretax cost of debt*(1-Tax Rate)=7%*(1-22%)
=7%*(0.78)=0.0546 or 5.46%