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Sheet1

7 CP Weighted Average Cost of Capital (WACC)

(pre tax)

$ 1,200

$ 200

$ 1,000

Interest Expense $ 200

Mail the dividend $

$ 1,000

$ 320 $ 400

Unit

Five Steps
My work shows Debt at 7.5% and Tax Rate at 40%, the assignment numbers are different
Bankers and Investors – expect to be paid : Portion of Capital Attained (Weight) Stated Cost of Capital or Debt Step 3 After-tax Cost Apply Weights to Cost of Capital
Bankers

Interest Expense 0.360 0.075 Step 4
Preferred Stock Dividend – Yield 0.140 0.070 0.0700 Step 1
(Retained Earnings)Common~ Dividend – Yield 0.500 0.118 0.1180 Step 2
100% Step 5
STEP 3
I Borrow I sell Stock
Income $ 1,200
Operating Expenses $ 200
Operating Income $ 1,000
$ – 0
Taxable Income $ 800
Apply a 40 % Tax Expense $ 320 $ 400
Mail your check to the IRS Cash Out
Step 3: Calculate the TRUE After tax cost of debt, Stated Cost x (1 – tax rate) of Step 3: I saved $80 in taxes because I borrowed and paid interest expense
.075(1-.40) After Tax Cost 4.5%
The true debt expense is smaller because it made your taxable income lower
Step 3 will be a separate slide

There is a second part to the problem —
You are a consultant to Pillbriar Company. Pillbriar’s target capital structure is 36% debt, 14% preferred, and 50% common equity. The interest rate on new debt is 7.5%, the yield on the preferred is 7.00%, the common stock ( we say Common Stock) is 11.75%, and the tax rate is 40%. What is Pillbriar’s WACC?
What are three methods for estimating the cost of common stock from retained earnings? Which of these methods provides the most accurate and reliable estimate?

Sheet2

Sheet3

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