The Patrick Company\'s cost of common equity is 16%, its before-tax cost of debt

Question

The Patrick Company's cost of common equity is 16%, its before-tax cost of debt is 13%, and its marginal tax rate is 40%. The stock sells at book value. Using the following balance sheet, calculate Patrick's WACC.

Assets                                                  Liabilities & Equity

Cash          $120                                                

Accounts receivable     $240

Inventories           $360                         Long-term debt    $1152

Plant and equipment, net    $2160         Common equity    $1728

Total asset            $2880                   Total liabilities and equity   $2880

Explanation / Answer

Cost of Common Equity(RE)   = 16% Cost ofDebt                (RD)   = 13% Marginal TaxRate        (T)     =   40% Target CapitalStructure: Common Equity(E/V) = $1,728 / $2,880   = 0.60 Debt                (D/V) = $1,152 / $2,880    = 0.40 CalculatingWeighted Average Cost of Capital (WACC): WACC = (E/V) *RE + (D/V) * RD (1-T) WACC = (0.60 *0.16) + [0.40 * 013 * (1-0.40)] WACC = 0.096 + (0.40 *0.078) WACC = 0.096 +0.0312 WACC = 0.1272 (or)12.72% Weighted AverageCost of Capital (WACC) = 12.72%

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