Compute the hurdle rate above based on the following.1. Note payable bank $2,000,000.00 with rate of 7.5%, The company has a tax rate of 30%.2. Bank Mortgage Loan $1,000,000.00 with rate of 6% The company has a tax rate of 30%.3. Preferred stock $750,000.00 with coupon rate 10%, The company has a tax rate of 30%. Common stock $250,000.00 use a rate of 14%, The company has a tax rate of 30%
To compute the hurdle rate, we need to first calculate the after-tax cost of each source of financing and then find the weighted average cost of capital (WACC) using the proportions of each source of financing.
1. Note Payable Bank:
The after-tax cost can be calculated by multiplying the interest rate by (1 - tax rate).
After-tax cost = 7.5% * (1 - 30%) = 7.5% * 0.7 = 5.25%.
2. Bank Mortgage Loan:
Similarly, the after-tax cost of the mortgage loan can be calculated as follows:
After-tax cost = 6% * (1 - 30%) = 6% * 0.7 = 4.2%.
3. Preferred Stock:
The after-tax cost of preferred stock is equal to the coupon rate since preferred stock dividends are not tax-deductible.
After-tax cost = 10%.
4. Common Stock:
The cost of common stock (equity) cannot be directly adjusted for taxes. However, we can calculate the after-tax cost by adjusting for the cost of debt using the weighted average cost of capital (WACC) formula.
Weighted Average Cost of Capital (WACC):
WACC is calculated by taking the weighted average of the after-tax cost of each source of financing. The weight represents the proportion of each source in the capital structure.
Let's assume that the proportion of each source is as follows:
Note payable bank = $2,000,000 / ($2,000,000 + $1,000,000 + $750,000 + $250,000) = 0.5
Bank mortgage loan = $1,000,000 / ($2,000,000 + $1,000,000 + $750,000 + $250,000) = 0.25
Preferred stock = $750,000 / ($2,000,000 + $1,000,000 + $750,000 + $250,000) = 0.1875
Common stock = $250,000 / ($2,000,000 + $1,000,000 + $750,000 + $250,000) = 0.0625
Now we can calculate the WACC:
WACC = (Weight of Note payable bank * After-tax cost of Note payable bank) + (Weight of Bank mortgage loan * After-tax cost of Bank mortgage loan) + (Weight of Preferred stock * After-tax cost of Preferred stock) + (Weight of Common stock * After-tax cost of Common stock)
WACC = (0.5 * 5.25%) + (0.25 * 4.2%) + (0.1875 * 10%) + (0.0625 * 14%)
Solving this equation will give us the hurdle rate above, which represents the overall cost of capital for the company.
To compute the hurdle rate, we need to first determine the after-tax cost of each source of financing.
Step 1: Calculate the after-tax cost of the Note Payable Bank:
After-tax cost of debt = Pre-tax cost of debt x (1 - Tax rate)
Pre-tax cost of debt = 7.5% = 0.075 (decimal form)
Tax rate = 30% = 0.30 (decimal form)
After-tax cost of debt = 0.075 x (1 - 0.30)
After-tax cost of debt = 0.075 x 0.70
After-tax cost of debt = 0.0525 = 5.25% (in decimal form)
Step 2: Calculate the after-tax cost of the Bank Mortgage Loan:
Pre-tax cost of debt = 6% = 0.06 (decimal form)
After-tax cost of debt = 0.06 x (1 - 0.30)
After-tax cost of debt = 0.06 x 0.70
After-tax cost of debt = 0.042 = 4.2% (in decimal form)
Step 3: Calculate the after-tax cost of Preferred Stock:
Coupon rate = 10% = 0.10 (decimal form)
After-tax cost of preferred stock = Coupon rate x (1 - Tax rate)
After-tax cost of preferred stock = 0.10 x (1 - 0.30)
After-tax cost of preferred stock = 0.10 x 0.70
After-tax cost of preferred stock = 0.07 = 7% (in decimal form)
Step 4: Calculate the after-tax cost of Common Stock:
Rate of return = 14% = 0.14 (decimal form)
After-tax cost of common stock = Rate of return x (1 - Tax rate)
After-tax cost of common stock = 0.14 x (1 - 0.30)
After-tax cost of common stock = 0.14 x 0.70
After-tax cost of common stock = 0.098 = 9.8% (in decimal form)
Step 5: Calculate the weighted average cost of capital (WACC):
WACC = (Weight of Note Payable Bank x After-tax cost of Note Payable Bank) +
(Weight of Bank Mortgage Loan x After-tax cost of Bank Mortgage Loan) +
(Weight of Preferred Stock x After-tax cost of Preferred Stock) +
(Weight of Common Stock x After-tax cost of Common Stock)
We don't have the weights for each source of financing, so we can't determine the WACC at this time. The hurdle rate would be the same as the WACC once we know the appropriate weights.