Problem:
A company is investigating the effect on its cost of capital with respect to the tax rate. Suppose there is a capital structure of 20% debt, 10% preferred stock, and 70% common stock. The cost of financing with retained earnings is re = 12%, the cost of preferred stock financing is rPS = 7%, and the before-tax cost of debt is rd= 9%.
Requirement:
Question: Calculate the weighted average cost of capital (WACC) given a tax rate of 35%.
Note: Provide support for your underlying principle.