Au Bon Marche, Inc., plans to maintain Its optimal capital structure ot 35 perce
ID: 2767673 • Letter: A
Question
Au Bon Marche, Inc., plans to maintain Its optimal capital structure ot 35 percent debt, 10 percent piefeued stocV, and 55 percent common stock and retained earnings tar into the future. The required tale of return on each component is debt: 9.2 per cent; preferred stock: 12 per cent; common stock and retained earnings-. 14 per cent. te-suming a 40 percent marginal tax rate, what is the minimum after-tax rate of return that Consequence must earn on its investments? a. 7.27% b. 10.83% C. 9.97% d. 11.23%Explanation / Answer
The company must earn minimum to meet its capital cost.
Cost of Debt = 9.20% Post tax Cost of Debt = Cost of Debt * (1 - tax rate) = 9.2% * (1-0.4) = 5.52% Post Tax Cost of Debt (Kd) = 5.16% Cost of Preference Stock (Kp) = 12% Cost of Equity (Ke) = 14% WACC = Kd*Wd + Kp*Wp + Ke*We where, Wd, Wp and We are weights of debt, preference and equity capital or target capital structure Wd = 35% Wp = 10% We = 5% WACC = 0.35 * 5.52% + 0.10 * 12% + 0.55*14% = 1.932% + 1.20% + 7.70% = 10.83% Hence, the correct answer is Option B - 10.83%Related Questions
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