Heavy Metal Corp.is a steel manufacturer that finances its operations with 40 percent debt,10 percent preferred stock,and 50 percent equity.Its net income is $100 million and it has a payout ratio of 35 percent.The interest rate on the company's debt is 11 percent.The preferred stock pays an annual dividend of $2 and sells for $20 a share.The company's common stock trades at $30 a share and its current dividend (D₀)of $2 a share is expected to grow at a constant rate of 8 percent per year.The flotation cost of external equity is 15 percent of the dollar amount issued,while the flotation cost on preferred stock is 10 percent.The company estimates that its WACC is 12.30 percent.Assume that the company is raising $150 million in total capital.What is the company's tax rate?

Question

Quizplus · Accepted Answer

The company's Weighted Average Cost of Capital (WACC) is given as 12.30%, which includes the cost of debt, preferred stock, and equity, adjusted for the tax benefit of debt. The cost of debt before taxes is 11%, but after taxes, it effectively contributes less to the WACC due to the tax shield. To find the tax rate, we use the formula for WACC and solve for the tax rate, given the cost of debt and the overall WACC. The correct tax rate aligns with the given WACC when considering the proportions of financing and the costs associated with each type of financing.