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30 July, 14:53

Mullineaux Corporation has a target capital structure of 65 percent common stock, 5 percent preferred stock, and 30 percent debt. Its cost of equity is 12 percent, the cost of preferred stock is 4 percent, and the pretax cost of debt is 5 percent. The relevant tax rate is 40 percent. a. What is Mullineaux's WACC? b. What is the aftertax cost of debt?

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  1. 30 July, 16:34
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    (a) 8.90%

    (b) 3.00%

    Explanation:

    (b) After tax cost of debt:

    = pretax cost of debt (1 - relevant tax rate)

    = 5% * (1 - 0.4)

    = 3.00%

    (a)

    Equity:

    Market value = 65

    weight = 0.65

    WACC = weight * cost of equity

    = 0.65 * 0.12

    = 7.80%

    Preferred stock:

    Market value = 5

    weight = 0.05

    WACC = weight * cost of equity

    = 0.05 * 0.04

    = 0.20%

    Debt:

    Market value = 30

    weight = 0.30

    WACC = weight * cost of equity (after tax)

    = 0.30 * 0.03

    = 0.90%

    Therefore,

    Mullineaux's WACC:

    = 7.80% + 0.20% + 0.90%

    = 8.90%
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