The Patrick Company\'s year-end balance sheet is shown below. Its cost of common

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 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 $1,207. 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 57 Inventories 360 Long-term debt $1,150 Plant and equipment, net 2,160 Common equity 1,663 Total assets $2,880 Total liabilities and equity $2,880

Explanation / Answer

cost of common equity =re= 16%

after-tax cost of debt=rd=before-tax cost of debt*(1-marginal tax rate)

=>after-tax cost of debt=rd=12%*(1-.40) =>after-tax cost of debt=rd=12%*(.6) =7.2%

market value equity=E=576 shares of common stock outstanding*4.00 =2304

market value of debt=D=1,207

weight of equity=E/(D+E)=2304/(2304+1207)=2304/3511=.656

weight of debt=1-weight of equity=1-.656=0.344

WACC= re*we+rd*we= .656*16%+0.344*7.2%= 10.496+ 2.4768 = 12.97%

Thus Patrick's WACC is 12.97%.

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