Due to the high demand and increase in prices for Red Caviar, Awers Inc., located just east of Seattle, Washington wants to build a salmon Hatchery in Alaska. It plans to raise $45,000,000 in the following ways:

Issue 1,500,000 shares at $17 each. (Assume the cost of equity = 10%)
Issue 100,000 Preferred Stocks at $25 each. (Assume cost on preferred stocks = 7%)
Borrow the remaining sum from the Bank. (Assume the cost of Debt = 5%)

The corporate tax rate in the US is 21%.

What will be Awers' Weighted Average Cost of Capital (WACC)?

Question

Due to the high demand and increase in prices for Red Caviar, Awers Inc., located just east of Seattle, Washington wants to build a salmon Hatchery in Alaska. It plans to raise $45,000,000 in the following ways:

Issue 1,500,000 shares at $17 each. (Assume the cost of equity = 10%)
Issue 100,000 Preferred Stocks at $25 each. (Assume cost on preferred stocks = 7%)
Borrow the remaining sum from the Bank. (Assume the cost of Debt = 5%)

The corporate tax rate in the US is 21%.

What will be Awers' Weighted Average Cost of Capital (WACC)?

BlackTom AI · Accepted Answer

WACC is calculated as the weighted sum of the costs of each capital component: WACC = (we * re) + (wp * rp) + (wd * rd * (1 − Tc)). Important concepts: compute market values of each financing source to get weights, use after-tax cost for debt (interest is tax-deductible), and apply given component costs.

Step-by-step calculation and intermediate steps:
1. Compute amounts raised:
- Common equity: 1,500,000 shares × $17 = $25,500,000
- Preferred stock: 100,000 × $25 = $2,500,000
- Total target financing = $45,000,000, so Debt = 45,000,000 − 25,500,000 − 2,500,000 = $17,000,000

2. Compute weights (proportion of total financing):
- we = 25,500,000 / 45,000,000 = 0.5666666667
- wp = 2,500,000 / 45,000,000 = 0.0555555556
- wd = 17,000,000 / 45,000,000 = 0.3777777778

3. Component costs (use after-tax cost for debt):
- re = 10% = 0.10
- rp = 7% = 0.07
- rd(after-tax) = rd × (1 − Tc) = 0.05 × (1 − 0.21) = 0.05 × 0.79 = 0.0395

4. Compute weighted contributions (showing intermediate multiplications):
- Equity contribution: we × re = 0.5666666667 × 0.10 = 0.05666666667
- Preferred contribution: wp × rp = 0.0555555556 × 0.07 = 0.00388888889
- Debt contribution: wd × rd(after-tax) = 0.3777777778 × 0.0395 = 0.01492222222

5. Sum to get WACC:
WACC = 0.05666666667 + 0.00388888889 + 0.01492222222 = 0.07547777778 ≈ 7.55%

Why this answer is correct:
- The calculation uses proper market-value weights, applies the corporate tax shield to debt, and uses the given component costs. The sum of the component contributions yields ≈7.55%.

Why the other options are incorrect:
- 6.41% and 7.33% are too low — they would result from incorrect weights or underestimating one of the component costs.
- 9.07% is too high — it likely results from failing to apply the tax shield to debt (or inflating the equity cost), which overstates WACC.
Conclusion: The correct WACC is 7.55%, which matches the provided answer.

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