The Williams Hotel Development Co. has identified a historic bank building that could be converted into a hotel. The location is in the heart of downtown Smithton, a densely populated metropolitan city. The structure was designed by an acclaimed architect and built in 1913. The 15 story building will be transformed into a chic boutique hotel with the hotel lobby, meeting rooms, café, and fitness center on the first two floors. The remaining 13 floors will contain 130 guest rooms.
The entire project will cost $35,000,000. Sixty percent of the project cost ($21,000,000) will be financed through debt, and $14,000,000 is being provided by equity investors. The lender is offering a favorable 12% interest rate on the $21,000,000, and the equity investors are requiring a return of 18% on their investment. The current business tax rate is 25%.
Because the structure is historic, the Williams Bennett Hotel Development Co. has been in discussions with the city government to determine if there are any public incentives for redeveloping this property. The development company knows the hotel supply in Smithton is underserved and that the city needs additional rooms to attract larger convention groups. The city would also gain from additional jobs, which would lower the unemployment rate. There are obvious benefits for both the City of Smithton and the Williams Bennett Hotel Development Co. Calculate the WACC and show step-by-step calculations for the weight of debt, cost of debt, tax effect, weighted cost of debt, weight of equity, cost of equity, and weighted cost of equity. Explain the tax effect and its relation to the interest portion of debt service.