Turnbull Co. is considering a project that requires an initial investment of $570,000. The firm will raise the $570,000 in capital by issuing $230,000 of debt at a before-tax cost of 9.6%, $20,000 of preferred stock at a cost of 10.7%, and $320,000 of equity at a cost of 13.5%. The firm faces a tax rate of 25%. What will be the WACC for this project

Question

Business

Terry Liu

20 March, 19:05

Turnbull Co. is considering a project that requires an initial investment of $570,000. The firm will raise the $570,000 in capital by issuing $230,000 of debt at a before-tax cost of 9.6%, $20,000 of preferred stock at a cost of 10.7%, and $320,000 of equity at a cost of 13.5%. The firm faces a tax rate of 25%. What will be the WACC for this project

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Answers (1)

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Twig · Answer 1

WACC = 10.868%

Explanation:

The following data table will show the easiest way to calculate weighted average cost of capital.

Capital components Investment ($) Weight

Debt Capital (Wd) 230,000 230,000 : 570,000 = 0.40

Equity Capital (We) 320,000 320,000 : 570,000 = 0.56

Preference capital (Wp) 20,000 20,000 : 570,000 = 0.04

Total Investment $570,000 1.00

We know,

WACC = [Wd * Kd (1 - T) ] + [Wp * kp] + [We * ke]

Given,

Kd (1 - T) = 9.6% * (1 - 0.25) = 7.2%

kp = 10.7%

ke = 13.5%

WACC = [0.40 * 7.2%] + [0.04 * 10.7%] + [0.56 * 13.5%]

or, WACC = 2.88% + 0.428% + 7.56%

Therefore, WACC = 10.868%