Given the following information on Big Brothers Inc capital

Given the following information on Big Brothers, Inc. capital structure, compute the company’s weighted average cost of capital (WACC). The company’s marginal tax rate is 40%.

Round the answer to two decimal places in percentage form. (Write the percentage sign in the \"units\" box)

Solution

WACC = 10.84%

Explanation;

First of all let’s calculate percent of capital structure (Weight) for common stock;

Type of capital

Percent of capital structure

Before-tax component cost

Bond

60%

10.87%

Preferred stock

10%

17.64%

Common stock (100% - 60% - 10%)

30%

17.25%

Now let’s calculate after tax cost of bond;

After tax cost of Bond = Before tax cost * (1 – tax rate)

After tax cost of Bond = 10.87% * (1 – 0.40)

After tax cost of bond = 6.52%

Now let’s calculate WACC;

(6.52% * 0.60) + (17.64% * 0.10) + (17.25% * 0.30)

= 3.91% + 1.76% + 5.17%

= 10.84% (Approx.)