The Patrick Company\'s cost of common Equity is 16 percent, itsbefore-tax cost o

Question

The Patrick Company's cost of common Equity is 16 percent, itsbefore-tax cost of debt is 13 percent and its marginal tax rate is40 percent. The stock sells at book value. Using thefollowing balance sheet, calculate Patrick's WACC. Assets Cash                                 $120 AccountsReceiveables      240 Inventories                        360                           Longtermdebt                     $1,152 Plant and equipment,net   2160                          CommonEquity                     1,728 TotalAssets                  $2,880                           Totalliabilities andequity      $2,880
The Patrick Company's cost of common Equity is 16 percent, itsbefore-tax cost of debt is 13 percent and its marginal tax rate is40 percent. The stock sells at book value. Using thefollowing balance sheet, calculate Patrick's WACC. Assets Cash                                 $120 AccountsReceiveables      240 Inventories                        360                           Longtermdebt                     $1,152 Plant and equipment,net   2160                          CommonEquity                     1,728 TotalAssets                  $2,880                           Totalliabilities andequity      $2,880

Explanation / Answer

Cost of Common Equity(RE)   = 16% Cost ofDebt                (RD)   = 13% Marginal TaxRate        (T)     =   40% Target CapitalStructure: Common Equity(E/V) = $1,728 / $2,880   = 0.60 Debt                (D/V) = $1,152 / $2,880    = 0.40 CalculatingWeighted Average Cost of Capital (WACC): WACC = (E/V) *RE + (D/V) * RD (1-T) WACC = (0.60 *0.16) + [0.40 * 013 * (1-0.40)] WACC = 0.096 + (0.40 *0.078) WACC = 0.096 +0.0312 WACC = 0.1272 (or)12.72% Weighted AverageCost of Capital (WACC) = 12.72% Cost of Common Equity(RE)   = 16% Cost ofDebt                (RD)   = 13% Marginal TaxRate        (T)     =   40% Target CapitalStructure: Common Equity(E/V) = $1,728 / $2,880   = 0.60 Debt                (D/V) = $1,152 / $2,880    = 0.40 CalculatingWeighted Average Cost of Capital (WACC): WACC = (E/V) *RE + (D/V) * RD (1-T) WACC = (0.60 *0.16) + [0.40 * 013 * (1-0.40)] WACC = 0.096 + (0.40 *0.078) WACC = 0.096 +0.0312 WACC = 0.1272 (or)12.72% Weighted AverageCost of Capital (WACC) = 12.72%

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