P14-9 Calculating WACC [LO3] (Click to select)On an aftertax basis, preferred st

Question

P14-9 Calculating WACC [LO3]

         
         (Click to select)On an aftertax basis, preferred stock is cheaper than the debt.On an aftertax basis, debt is cheaper than the preferred stock.

Mullineaux Corporation has a target capital structure of 60 percent common stock, 5 percent preferred stock, and 35 percent debt. Its cost of equity is 14 percent, the cost of preferred stock is 6 percent, and the cost of debt is 8 percent. The relevant tax rate is 35 percent. (Do not include the percent sign (%). Round your answer to 2 decimal places. (e.g., 32.16))

Explanation / Answer

Mullineaux Corporation has a target capital structure of 60 percent common stock, 5 percent preferred stock, and 35 percent debt. Its cost of equity is 11 percent, the cost of preferred stock is 5.5 percent, and the cost of debt is 7.2 percent. The relevant tax rate is 35 percent.

a.       What is Mullineaux's WACC?

b.      The company president has approached you about Mullineaux's capital structure. He wants to know why the company doesn't use more preferred stock financing, since it costs less than debt. What would you tell the president?

       a.     Using the equation to calculate the WACC, we find:

               WACC = .60(.11) + .05(.055) + .35(.072)(1

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