A Company is considering purchasing a piece of new equipment for $1,000,000. The

Question

A Company is considering purchasing a piece of new equipment for $1,000,000.  The equipment will reduce cost by $280,000 (assume the savings occurs at the end of the year) per year for 5 years.  At that time the salvage value of the equipment is $50,000.  Current cash inflow for is $1,200,000.  The Company requires a 6% ROI.Assume: A Company has a targeted capital structure of 30% for debt, 10% for preferred stock and 60% for common equity.  Before tax cost of debt is 11%, cost of preferred stock is 10.3% and the cost of common equity is 14.6%.  A Company’s tax rate is 40%
What is A Company’s WACC?  Show all calculations

Explanation / Answer

cost of debt after tax = 11% ( 1 - 0.40)

= 11% * 0.6

= 6.6%

cost of common equity= 14.6%

cost of preferred stock is 10.3%

cost weightage WACC

Common equity 14.6% 0.60 8.76%

Preferred stock 10.3% 0.10 1.03%

Debt 6.6% 0.30 1.98%

11.77%

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