Question

Cream and Crimson Foods has a target capital structure of calling for 42.00 percent debt, 3.00 percent preferred stock, and 55.00 percent common equity (retained earnings plus common stock). Its before-tax cost of debt is 12.00 percent. The tax rate is 40.00%. Its cost of preferred stock is 10.76%. Its cost of common equity is 12.22%.

Find the WACC for Cream and Crimson Foods?

Answer 1

To calculate the Weighted Average Cost of Capital (WACC) for Cream and Crimson Foods, we use the following formula:

\[
\text{WACC} = \left( w_d \times r_d \times (1 - T) \right) + \left( w_{ps} \times r_{ps} \right) + \left( w_e \times r_e \right)
\]

Where:
- \( w_d \) = weight of debt
- \( r_d \) = cost of debt
- \( T \) = tax rate
- \( w_{ps} \) = weight of preferred stock
- \( r_{ps} \) = cost of preferred stock
- \( w_e \) = weight of equity
- \( r_e \) = cost of equity

### Given Data:
- Weight of Debt (\( w_d \)): 42.00% or 0.42
- Cost of Debt (\( r_d \)): 12.00% or 0.12
- Tax Rate (\( T \)): 40.00% or 0.40
- Weight of Preferred Stock (\( w_{ps} \)): 3.00% or 0.03
- Cost of Preferred Stock (\( r_{ps} \)): 10.76% or 0.1076
- Weight of Common Equity (\( w_e \)): 55.00% or 0.55
- Cost of Common Equity (\( r_e \)): 12.22% or 0.1222

### Step-by-Step Calculation:

1. **Calculate the after-tax cost of debt:**
\[
r_d(1 - T) = 0.12 \times (1 - 0.40) = 0.12 \times 0.60 = 0.072
\]

2. **Calculate each component of WACC:**
- **Cost of Debt component:**
\[
w_d \times r_d \times (1 - T) = 0.42 \times 0.072 = 0.03024
\]

- **Cost of Preferred Stock component:**
\[
w_{ps} \times r_{ps} = 0.03 \times 0.1076 = 0.003228
\]

- **Cost of Common Equity component:**
\[
w_e \times r_e = 0.55 \times 0.1222 = 0.06721
\]

3. **Add all components together to find WACC:**
\[
\text{WACC} = 0.03024 + 0.003228 + 0.06721 = 0.100678
\]

### Final Result:
\[
\text{WACC} \approx 0.10068 \text{ or } 10.07\%
\]

Therefore, the Weighted Average Cost of Capital (WACC) for Cream and Crimson Foods is approximately **10.07%**.