PrimaCare has a capital structure that consists of $7 million of debt,$2 million of preferred stock,and $11 million of common equity,based upon current market values.The firm's yield to maturity on its bonds is 7.4%,and investors require an 8% return on the firm's preferred and a 14% return on PrimaCare's common stock.If the tax rate is 35%,what is PrimaCare's WACC?
A) 7.21%
B) 8.12%
C) 10.18%
D) 12.25%

Question

Quizplus · Accepted Answer

To calculate the Weighted Average Cost of Capital (WACC), we use the formula:$$ WACC = \frac{E}{V} \times Re + \frac{D}{V} \times Rd \times (1 - Tc) + \frac{P}{V} \times Rp $$Where:- $E$ is the market value of the equity ($11 million),- $D$ is the market value of the debt ($7 million),- $P$ is the market value of the preferred stock ($2 million),- $V$ is the total market value of the firm's financing ($11m + $7m + $2m = $20 million),- $Re$ is the cost of equity (14%),- $Rd$ is the cost of debt (7.4%),- $Rp$ is the cost of preferred stock (8%),- $Tc$ is the corporate tax rate (35%).Plugging in the numbers:$$ WACC = \frac{11}{20} \times 0.14 + \frac{7}{20} \times 0.074 \times (1 - 0.35) + \frac{2}{20} \times 0.08 $$$$ WACC = 0.55 \times 0.14 + 0.35 \times 0.074 \times 0.65 + 0.1 \times 0.08 $$$$ WACC = 0.077 + 0.016845 + 0.008 $$$$ WACC = 0.101845 $$$$ WACC = 10.18\% $$Therefore, the correct answer is 10.18%, which corresponds to choice C.

PrimaCare Has a Capital Structure That Consists of $7 Million