Baxter Inc.has a target capital structure of 30% debt,15% preferred stock,and 55% common equity.The company's after-tax cost of debt is 7%,its cost of preferred stock is 11%,its cost of retained earnings is 15%,and its cost of new common stock is 16%.The company stock has a beta of 1.5 and the company's marginal tax rate is 35%.What is the company's weighted average cost of capital if retained earnings are used to fund the common equity portion?

Question

Quizplus · Accepted Answer

The company's weighted average cost of capital (WACC) can be calculated using the formula: WACC = (E/V * Re) + (D/V * Rd * (1 - Tc)) + (P/V * Rp), where E is the market value of the equity, D is the market value of the debt, P is the market value of the preferred stock, V is the total market value of the company (E + D + P), Re is the cost of equity, Rd is the cost of debt, Rp is the cost of preferred stock, and Tc is the corporate tax rate. Given that the company uses retained earnings for the common equity portion, the cost of equity (Re) is 15%. Plugging in the values: WACC = (0.55 * 15%) + (0.30 * 7% * (1 - 0.35)) + (0.15 * 11%) = 12.00%.