Targaryen Corporation has a target capital structure of 60 percent common stock, 5 percent preferred stock, and 35 percent debt.

Targaryen Corporation has a target capital structure of 60 percent common stock, 5 percent preferred stock, and 35 percent debt. Its cost of equity is 12 percent, the cost of preferred stock is 8 percent, and the pretax cost of debt is 9 percent. The relevant tax rate is 24 percent.

a.	What is the company’s WACC? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
b.	What is the aftertax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Explanation:

a.

Using the equation to calculate the WACC, we find:

WACC = .60(.12) + .05(.08) + .35(.09)(1 – .24)

WACC = .0999, or 9.99%

b.

The aftertax cost of debt is:

RD = .09(1 – .24)

RD = .0684, or 6.84%

Hence, on an aftertax basis, debt is cheaper than the preferred stock.