Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 38

Weighted-Average Cost of Capital (WACC)

a. Micro Advantage, Inc., issued a $5,000,000, 20-year bond a year ago at 98 with a stated rate of 9 percent. Today, the bond is selling at 110. If the firm’s tax bracket is 30 percent, what is the current after-tax cost of this debt?

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b. Micro Advantage, Inc., has $5,000,000 preferred stock outstanding that it sold for $24 per share. The preferred stock has a per share par value of $25 and pays a $3 dividend per year. The current market price is $30 per share. The firm’s tax bracket is 30 percent. What is the after-tax cost of the preferred stock?

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c. In addition to the bonds and preferred stocks described in (a) and (b) above, Micro Advantage has outstanding 50,000 shares of common stock that has a par value of $10 per share and a current market price of $170 per share. The expected after-tax market return on the firm’s common equity is 20 percent. What is Micro Advantage’s weighted-average cost of capital (WACC)?

Step 1 of 3

Weighted-Average Cost of Capital (WACC)(20-25 minutes)

?a.?

Bond interest expense before tax =	$5,000,000 x 9%	=	$450,000
Income tax savings on bond interest expense =	$450,000 x 30%	=	135,000
After-tax bond interest expense		=	$315,000
Market value of bond:	$5,000,000 x 110%	=	$5,500,000
Current after-tax cost of this debt:
	$SSS315,000 ÷ $5,500,000	=	5.73%