Reactive Power Generation has the following capital structure. Its corporate tax rate is 21%. Security Market Value Required Rate of Return Debt $ 20 million 6 % Preferred stock 10 million 8 Common stock 50 million 12 What is its WACC?

Question

Business

Zaniyah Christensen

9 May, 11:56

Reactive Power Generation has the following capital structure. Its corporate tax rate is 21%. Security Market Value Required Rate of Return Debt $ 20 million 6 % Preferred stock 10 million 8 Common stock 50 million 12 What is its WACC?

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Answers (1)

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Reginald Raymond · Answer 1

WACC is 9.69%

Explanation:

The formula for WACC in this scenario is adapted to show preferred stock, hence WACC formula is given below:

WACC=E/V*Ke+P/V*Kp+D/V*Kd * (1-tax)

E implies equity value given as $50 million

P is the preferred stock value which is $10 million

D is the debt value which is $20 million

V is the sum of the finances available to Reactive Power Generation company and it is calculated as $50 million+$20 million + $10 million = $80 million

Ke is the cost of equity of 12%

Kd is the cost of debt 6%

Kp is the cost of preferred stock of 8%

tax rate is 21% or 0.21

WACC=50/80*12%+10/80*8%+20/80*6% * (1-0.21)

WACC = (50/80*12%) + (10/80*8%) + (20/80*4.74%)

WACC=9.69%

Note that I changed cost of debt to after-tax cost of debt before finally computing the WACC.