The Patrick Company\'s year-end balance sheet is shown below. Its cost of common
ID: 2750768 • Letter: T
Question
The Patrick Company's year-end balance sheet is shown below. Its cost of common equity is 14%, its before-tax cost of debt is 12%, and its marginal tax rate is 40%. Assume that the firm's long-term debt sells at par value. The firm’s total debt, which is the sum of the company’s short-term debt and long-term debt, equals $1,116. The firm has 576 shares of common stock outstanding that sell for $4.00 per share. Calculate Patrick's WACC using market value weights. Round your answer to two decimal places.
Explanation / Answer
Ans.:- Weighted average cost of the capital as per market value weights is as follows:
WACC = r(E) x w(E) + r(D) x (1-t) x w(D)
Where
r (E) = Cost of Equity = 14%
r (D) = Cost of Debt befor tax = 12%
t = Tax Rate = 40%
w(E) = Weight of Equity
= Total Market value of Equity / (Total Market value of Equity + Total Market valud of Debt)
= (576 x 4.00) / (576x4 + 1116)
= 2304 / (2304+1116)
= 2304 / 3420
= 0.674
w(D) = Weight of Debt
= Total Market value of Debt / (Total Market value of Equity + Total Market valud of Debt)
= 1116 / (576x4 + 1116)
= 1116 / (2304+1116)
= 1116 / 3420
= 0.326
Placing the value in the formula
WACC = 0.14x0.674 + 0.12x(1.00 - 0.40)x0.326
= 0.0944 + 0.0235
= 0.1179 or 11.79%
Thus WACC using market value weights is 11.79%.
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