The Patrick Company\'s year-end balance sheet is shown below. Its cost of common
ID: 2774873 • Letter: T
Question
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 10%, 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 $1,143. 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.
%
Assets Liabilities And Equity Cash $ 120 Accounts payable and accruals $ 10 Accounts receivable 240 Short-term debt 43 Inventories 360 Long-term debt $1,100 Plant and equipment, net 2,160 Common equity 1,727 Total assets $2,880 Total liabilities and equity $2,880Explanation / Answer
Cost of Equity = 16%
Pre-tax Cost of Debt = 10%
Marginal Tax Rate = 40%
Total Debt = $ 1,143
Long Term Debt = $ 1,143 - $ 43 = $ 1,100
No shares outstanding = 576
Market Price = $ 4
Market Value of Equity = 576 * 4 = $ 2,304
Total Market Value of Debt + Equity = $ 2304 + $ 1100 = $ 3,404
Market Value weight of equity = $ 2304 / $ 3404 = 0.6769 or 67.69%
Market Value weight of Long-term Debt = $1100/$3404 = 0.3231 or 32.31%
Weighted Average cost of Capital
WACC = weight of equity * cost of equity + weight of debt * pre-tax cost of debt * (1-Tax rate)
WACC = 0.6769 * 0.16 + 0.3231 * 0.10 * (1-0.40)
= 0.108304 + 0.019386 = 0.12769 or 12.77% (rounded off)
Weighted Average Cost of Capital based on market weights = 12.77%
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