10-9 WACC The Patrick Company’s year-end balance sheet is shown below. Its cost

Question

10-9 WACC The Patrick Company’s year-end balance sheet is shown below. Its cost of common equity is 16%, its before-tax cost of debt is 13%, and its marginal tax rate is 40%. Assume that the firm’s long-term debt sells at par value. The firm has 576 shares of common stock outstanding that sell for $4.00. Calculate Patrick’s WACC using market value weights.

Assets Liabilities and Equity
---------------------------------------------------------------------------------------------------------
Cash $ 120
Accounts receivable 240
Inventories 360 Long-term debt $1,152
Plant and equipment 2,160 Common equity 1,728
---------------------------------------------------------------------------------------------------------- Total assets $2,880 Total liabilities $2,880

Explanation / Answer

WACC = (D/V) Cost of debt*(1-Taxes) + (E/V) Cost of equity. V Is value of the firm = Market value of debt + Market value of equity. = $1,152 + $1,1728 = $2,880 D/V = $1,152/$2,880 =40% E/V =$1,1728/$2,880 =60%. WACC =40%*13%*(1-40%) + 60%*16% =0.4*13%(0.6) + 0.6*16% =3.12% + 9.6% =12.72%. Therefore WACC of the firm is 12.72%.

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