Healthy Foods has a target capital structure of 55 percent common stock, 5 percent preferred stock, and 40 percent debt. Its cost of equity is 14.3 percent, the cost of preferred stock is 8.9 percent, and the pre-tax cost of debt is 8.1 percent. What is the company's WACC if the applicable tax rate is 34 percent?

Question

Quizplus · Accepted Answer

First, we need to calculate the after-tax cost of debt: 
After-tax cost of debt = Pre-tax cost of debt x (1 - Tax rate) = 8.1% x (1 - 0.34) = 5.34% 
Then, we can calculate the weighted average cost of capital (WACC): 
WACC = (Weight of equity x Cost of Equity) + (Weight of preferred stock x Cost of Preferred stock) + (Weight of debt x After-tax cost of debt) 
WACC = (0.55 x 14.3%) + (0.05 x 8.9%) + (0.40 x 5.34%) = 10.45% 
Therefore, the answer is D.

Healthy Foods Has a Target Capital Structure of 55 Percent