Mullineaux Corporation has a target capital structure of 50 percent common stock

Question

Mullineaux Corporation has a target capital structure of 50 percent common stock, 5 percent preferred stock, and 45 percent debt. Its cost of equity is 15 percent, the cost of preferred stock is 6 percent, and the cost of debt is 8 percent. The relevant tax rate is 35 percent. What is Mullineaux's WACC? The company president approaches you about Mullineaux's Capital structure. He wants to know why the company doesn't use more preferred stock financing because it costs less than debt. What would you tell the president?

Explanation / Answer

The WACC formula states that: WACC = kd * wd * (1 - t) + kp * wp + ke * we Where: kd = cost of debt wd = % debt t = tax rate kp = cost of preferred stock wp = % preferred stock ke = cost of common equity we = % common equity So your formula is: WACC = 35% * 8% * (1-35%) + 5% * 6% + 60% * 14% WACC = 10.52%

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