Question

Mullineaux Corporation has a target capital structure of 65 percent common stock, 5 percent preferred stock, and 30 percent debt. Its cost of equity is 12 percent, the cost of preferred stock is 4 percent, and the pretax cost of debt is 5 percent. The relevant tax rate is 40 percent. a. What is Mullineaux’s WACC?b. What is the aftertax cost of debt?

Answer 1

(a) 8.90%

(b) 3.00%

Step-by-step explanation:

(b) After tax cost of debt:

= pretax cost of debt (1 - relevant tax rate)

= 5% × (1 - 0.4)

= 3.00%

(a)

Equity:

Market value = 65

weight = 0.65

WACC = weight × cost of equity

= 0.65 × 0.12

= 7.80%

Preferred stock:

Market value = 5

weight = 0.05

WACC = weight × cost of equity

= 0.05 × 0.04

= 0.20%

Debt:

Market value = 30

weight = 0.30

WACC = weight × cost of equity (after tax)

= 0.30 × 0.03

= 0.90%

Therefore,

Mullineaux’s WACC:

= 7.80% + 0.20% + 0.90%

= 8.90%