The target capital structure for Petersen, Inc. is 30% debt, 20% preferred stock and 50% equity. The after-tax cost of debt is 6%; the cost of preferred stock is 10% and the cost of equity is 14%. (Floatation costs are already included in the costs of preferred stock and equity.) What is Petersen's WACC based on the target capital structure?

Question

Quizplus · Accepted Answer

WACC = (w_d * r_d * (1 - T)) + (w_ps * r_ps) + (w_e * r_e)

w_d = 0.3; r_d = 6%; T = not given, assuming 0.35 (35%); w_ps = 0.2; r_ps = 10%; w_e = 0.5; r_e = 14%

Substituting the values, we get:

WACC = (0.3 * 0.06 * (1 - 0.35)) + (0.2 * 0.1) + (0.5 * 0.14)
      = 0.018 * 0.65 + 0.02 + 0.07
      = 0.01 + 0.02 + 0.07
      = 0.1 or 10%

Therefore, the best choice is C, which is 10.8% (incorrect). The correct answer is B, which is 10.0%.

The Target Capital Structure for Petersen, Inc