Milton Parker has a capital structure that consists of $7 million of debt,$2 million of preferred stock,and $11 million of common equity,based upon current market values.Parker's yield to maturity on its bonds is 7.4%,and investors require an 8% return on Parker's preferred and a 14% return on Parker's common stock.If the tax rate is 35%,what is Parker's WACC?
A) 7.21%
B) 8.12%
C) 10.18%
D) 12.25%

Question

Quizplus · Accepted Answer

First, we need to calculate the weights of debt, preferred stock, and common equity:
Debt weight = $7 million / ($7 million + $2 million + $11 million) = 0.35
Preferred stock weight = $2 million / ($7 million + $2 million + $11 million) = 0.1
Common equity weight = $11 million / ($7 million + $2 million + $11 million) = 0.55

Next, we need to calculate the after-tax cost of debt:
After-tax cost of debt = Yield to maturity * (1 - Tax rate) = 0.074 * (1 - 0.35) = 0.0481

Then, we can calculate the cost of preferred stock and common equity:
Cost of preferred stock = 0.08
Cost of common equity = 0.14

Finally, we can calculate the weighted average cost of capital (WACC):
WACC = (Debt weight * After-tax cost of debt) + (Preferred stock weight * Cost of preferred stock) + (Common equity weight * Cost of common equity)
WACC = (0.35 * 0.0481) + (0.1 * 0.08) + (0.55 * 0.14) = 0.1018 or 10.18%

Milton Parker Has a Capital Structure That Consists of $7