The Manx Company was recently formed to manufacture a new product. It has the fo

Question

The Manx Company was recently formed to manufacture a new product. It has the following capital structure in market value terms:
Debentures: $6,000,000
Preferred Stock: $2,000,000
Common Stock: $8,000,000

The company has a marginal tax rate of 40 percent. A study of publicity held companies in this line of business suggests that the required rate of return on equity is about 17 percent (The CAPM approach was used to determine the required rate of return.) The Manx Company's debt is currently yielding 13 percent, and its perferred stock is yielding 12 percent. Compute the firm's present weighted cost of capital.

Explanation / Answer

WACC = E/V(Re)+D/V(Rd)(1-Tc)+P/V(Rp) D/V: the weight of debt (percentage of debt allocated to finance the project) E/V: the weight of equity (percentage of equity allocated to finance the project) P/V: the weight of preferred stocks (percentage of preferred stocks allocated to finance the project) = (.5)(.17)+(6/16)(.13)(1-.4)+(2/16)(.12) =.12925 = 12.9%

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