Johnson has a target capital structure of 60% common stock, 5% preferred stock and 35% debt. The firm's cost of equity is 10%, its cost of preferred is 4% and the pretax cost of debt is 6%. If the tax rate is 34%, what is Johnson's weighted average cost of capital?

Question

Johnson has a target capital structure of 60% common stock, 5% preferred stock and 35% debt. The firm's cost of equity is 10%, its cost of preferred is 4% and the pretax cost of debt is 6%.   If the tax rate is 34%, what is Johnson's weighted average cost of capital? ​

Quizplus · Accepted Answer

To calculate Johnson's weighted average cost of capital (WACC), we need to first find the cost of each component of the capital structure, considering the weights given:

Cost of equity (Re) = 10%
Cost of preferred (Rp) = 4%
Pretax cost of debt (Rd) = 6%
Tax rate (T) = 34%

Weight of common stock = 60%
Weight of preferred stock = 5%
Weight of debt = 35%

Now, using these values, we can calculate WACC as:

WACC = (Re x 0.6) + (Rp x 0.05) + (Rd x 0.35) x (1 - T)
WACC = (0.1 x 0.6) + (0.04 x 0.05) + (0.06 x 0.35) x (1 - 0.34)
WACC = 0.06 + 0.002 + 0.023 x 0.66
WACC = 0.06 + 0.002 + 0.015
WACC = 0.077 or 7.59%

Therefore, the best choice is B.

Johnson Has a Target Capital Structure of 60% Common Stock