such à low rate? Wha t it you were the se lling firm? Calculating the weighted a
ID: 2802043 • Letter: S
Question
such à low rate? Wha t it you were the se lling firm? Calculating the weighted average cost of capital. Suppose that Tale Inc. has the following target capital structure: 50 percent stock 40 percent debt, and 10 percent preferred stock. Its cost of equity is estimated at 10 percent, that of debt 6 percent, and that of preferred stock 4.5 percent. The tax rate is 35 percent. 7. a. What is Tale's cost of capital? b. Should Tale use more preferred stock financing than debt financing since it is cheaper?Explanation / Answer
a) Cost of capital =
Weight of debt * After yax cost of debt + Weight of equity*Cost of equity + Weight of preferance stock*Cost of preferance stock
= 0.50*10 + 0.40*6*(1-0.35) + 0.10*4.5
= 5 + 1.56 + 0.45
= 7.01%
b) If you look at the cost of debt carefully, after tax cost of debt is more cheaper than preferred stock
After tax cost of debt = 6*(1-0.35) = 3.9%
Preferred stock = 4.5%
So, the answer is
No, more of preferred stock may not be used
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