[rlg5150]

A company has the following target capital structure and costs:

---

Proportion of capital structure

---

Cost of capital

Debt

---

30%

---

10%

Common stock— 60%

---

12%

Preferred stock—-10%

---

10%

What is the company’s weighted-average cost of capital?

Here’s what I thought:

Debt: .3 x .1 = .03

Common Stock: .6 x .12 = .072

Preferred Stock: .1 x .1 = .01

.03 + .072 + .01 = 11.2%

10 points to whoever can explain to me the right answer. I’ll give you a hint: it’s not 11.2%.

FAR - 85
AUD - 86
BEC - 84
REG - 88

[wobrie4]

You have common stock and preferred stock right. You need the after-tax cost of debt. What's the tax rate? I vaguely remember this problem on Becker….

On My Way to a CPA...

FAR- 83 (12/02/12) (Try #1...by some miracle)
BEC- 80 (2/23/13) (Try #1... by some miracle)
AUD- 77 (05/04/13) (Try #1... by some miracle)
REG- 79 (08/03/13)(Try #1... by some miracle)

[littlenumberrobot]

is this the same question you posted in the other thread? I think its missing the tax affect.

CA CPA - All because of the journey listed below
-----------------------------------------------------------------------
FAR - 53('10), 8/25/12 79 PASSED!
REG - 66('11), 69('12), 12/06/12 77 PASSED!!
BEC - 58('10), 74('12), 01/05/13 77 PASSED!!!
AUD - 43('11), 66('12), 69('13), 74('13) 7/29/13 85 PASSED!!!!!

(Combinations of Roger, Yaeger, Wiley Book, Wiley TB, & NINJA Notes)

Ethics 90%

[littlenumberrobot]

OOPS double post

CA CPA - All because of the journey listed below
-----------------------------------------------------------------------
FAR - 53('10), 8/25/12 79 PASSED!
REG - 66('11), 69('12), 12/06/12 77 PASSED!!
BEC - 58('10), 74('12), 01/05/13 77 PASSED!!!
AUD - 43('11), 66('12), 69('13), 74('13) 7/29/13 85 PASSED!!!!!

(Combinations of Roger, Yaeger, Wiley Book, Wiley TB, & NINJA Notes)

Ethics 90%

[2012passtheCPA]

I was too late! I was going to say ‘tax effect the debt'.

[rlg5150]

So it's not just me, then.. I gave you the entire problem. The answer mentioned subtracting out the marginal tax but I guess they forgot to give it. I was wondering if there's some way to calculate it based on the information given.

FAR - 85
AUD - 86
BEC - 84
REG - 88

[FlipACoin]

You can calculate the tax rate once you have the answer 🙂 but short of that, unless there is some other tidbit in the problem that indirectly points out tax rate, you cannot answer the problem.

[sdgh1826]

Debt is taxable. Therefore:

Debt .3 x .07 (1 – tax rate, 1 – .3) = 0.021

CS .6 x.12 = 0.072

PS .1 x .1 = 0.01

Ans: 10.3% (I made the same mistake as you did the first time I encountered this probem).

Debt is cheaper than equity because it is taxable. Studying BEC too. Hope I helped a bit

Becker 2012, NINJA notes

[no.cruncher]

I was just working on the Cost of Capital Components and WACC this whole week, and I was searching for where that Tax Rate was accounted for: In any case, here's my regurgitation straight from my head, for my or your reference, and or correction 🙂

(Cost of Capital Components) = (CCC)

---

CdT : “After-tax Cost of Debt” = i rate ( 1 – .T )

Cps: “Net of Float, Cost of P/S” = [ P/S Divs / P/S Po ( 1 – .F ) ]

Cce: via R/E OR Issued C/S

Cr/e : “Cost of R/E Equity” = ( D1 / Po ) + *G

OR

Cc/s: “Net of Float, Cost of Newly Issued C/S Equity” = ( D1 / Po ) + *G

==========================================================

Weight A Average CC = WACC = WA*CdT + WA*Cps + WA*Cce

==========================================================

NOTE:

WACC ~ Target: Optimal Capital Structure : Increase S/H Wealth : Increase Stock P. : Increase Firm Value

Costs of Capital ~ Required Rates of Returns (RROR) by Investors and or Shareholders

Cc/s > Cr/e because External Funding via C/S has Stock Issuance Costs ~ Float %

Capital Source Funding Increases : (WACC) Increases : Marginal Cost of Capital (MCC) Increases

Long Run : MCC > WACC

D1 = Next Year's Dividends @ t = 1

Po = Initial Current Stock Price @ t = 0

.DPO = Dividends Payout Ratio = C/S Dividends / NI

*G = Retention Rate * ROE = ( 1 – .DPO ) ( NI / Equity ) = ( 1 – C/S Divs / NI ) ( NI / Equity ) = ( R/E / NI ) ( NI / Equity)

= ( R/E / NI)

G Dependent on RROR ~ Cc/s, Otherwise G not met!

FAR - 7/16/2012 *76 : 2.5mo [Exp. 1/2014]
AUD - 8/31/2012 *82 : 1mo
REG - 11/27/2012 *83 : 2.5mo
BEC - 2/27/2013 *80 : 2.5mo LET'S DO THIS!!!
Ethics - 3/13

[ 2011 Kaplan Self Study - Textbook, MP3s, FlashCards ]

CMA... Hmmm...???

[Author]

Replies