A corporation has the following balance sheet (liabilities side)
Current liabilities 2000
Long-term debt 5000
Preferred stock 2000
common stock 8000
retained earnings 3000
Currently the riskless interest rate is 8%; the corporate tax rate is 50%; the current price of a share of common stock is $20; and dividends have been level
at $1 per share per year for many years.
Recently company executives have considered expanding the existing business by acquiring a competitor. To do so they must caluculate the WACC of the
firm and estimate the NPV of the acquisition. Because the acquisition is of the same risk as the firm the WACC (unlevered equity cost) can be used.
A financial executive has used the following procedure to calculate the WACC. Debt and preferred cost are fixed claims offering a fairly secure
constant return and so their before tax cost is assumed to equal the riskless rate. The dividend yield has held constant at about 5%; so this is used as the
cost of new and retained equity (common plus reatined) and 10% current liabilities. Current liabilities are assumed to be costless; therefore the WACC is