Targaryen Corporation has a target capital structure of 65 percent common stock,

Question

Targaryen Corporation has a target capital structure of 65 percent common stock, 10 percent preferred stock, and 25 percent debt. Its cost of equity is 9 percent, the cost of preferred stock is 4 percent, and the pretax cost of debt is 5 percent. The relevant tax rate is 21 percent. a. What is the company's WACC? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) What is the aftertax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) b. a WACC b. Cost of debt

Explanation / Answer

a) Calculation of WACC

WACC = (E/V * Ke) + (D/V) * Kd * (1 – Tax rate) + (P/V * Kp)

where

E = Market Value/weight of Equity = .65

V = Total market valueweight of equity, preferred stock & debt =100% = 1

Ke = Cost of Equity = 9%

D = Market Value/weight of Debt = .25

Kd = pre tax Cost of Debt = 5%

P = Market Value/weight of preferred stock = .1

Kp = Cost of preferred stock = 4%

Tax Rate = Corporate Tax Rate = 21%

WACC = (.65* 9) + (.25 * 5* (1 – .21)) + (.1*4)

= 5.85+.9875+.4

= 7.2375

= 7.24%

b) Calculation of after-tax cost of debt

After-tax cost of debt = cost of debt * (1-Tax Rate)

= 5*(1-.21)

= 5*.79

= 3.95%

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