Question

The company's after‐tax cost of debt is 14% and the cost of equity is 16%. Given that the company's weighted average cost of capital is 14.5%, its cost of preferred equity is closest to:

a)4.5%


b)3.5%


c)4.0%

Answer 1

c)4.0%

Step-by-step explanation:

The formula to compute WACC is shown below:

Weighted average cost of capital = Weightage of debt × cost of debt + (Weightage of preferred equity) × (cost of preferred equity) + (Weightage of common stock) × (cost of common stock)

14.5% = (0.45 × 14%) + (0.05 × cost of preferred equity) + (0.50 × 16%)

14.5% = 6.3% + (0.05 × cost of preferred equity) + 8%

After solving this, the cost of preferred equity would be 4%