7. Brite Lighting Corporation wants to investigate the effect on its cost of cap

Question

7. Brite Lighting Corporation wants to investigate the effect on its cost of capital based on the rate at which the company is taxed. The firm wishes to maintain a capital structure of 30% debt, 10% preferred stock, and 60% common stock. The cost of financing with retained earnings is 14% (i.e., rs = 14%), the cost of preferred stock financing is 9% (rps = 9%), and the before-tax cost of debt is 11% (rd = 11%). Calculate the weighted average cost of capital (WACC) given the tax rate assumptions in parts (a) to (c) below. a) tax rate 40% b) tax rate 35% c) tax rate 25% I already have my answers just want to verify I have them right.

Explanation / Answer

the calculation of after tax cost of debt at 40% tax rate = Cost of debt(1-tax) = 11(1-0.4) = 6.6% 35% tax rate = Cost of Debt(1-tax) = 11(1-0.35) = 7.15% 25% tax rate = Cost of Debt(1-tax) = 11(1-0.25) = 8.25% Preferential stock and equity stock after tax cost remains same. calculation of WACC Particulars Capital stucture After tax Individual costs WACC at (percentage) at different tax rates at different tax rates 40% 35% 25% 40% 35% 25% --------------------------------------------------------------------------------------------------------------- (A) (B) (A) x (B) ==================================================================================== Debt 30% 6.6 7.15 8.25 1.98 2.145 2.475 Pref stock 10% 9 9 9 0.90 0.90 0.90 Equity Stock 60% 14 14 14 8.40 8.40 8.40 ===================================================================================== Weighted Average Cost of capital = 11.28 11.445 11.775 ======================================================================================

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