Final answer:
Ford's weighted average cost of capital (WACC) is calculated using the cost of equity, cost of preferred stock, and after-tax cost of debt, weighted by their respective proportions in the capital structure. The correct answer, after calculations, is 9.75%, corresponding to option D.
Step-by-step explanation:
The question asks to calculate Ford's weighted average cost of capital (WACC) given the market values of its equity, preferred stock, and debt, along with other pertinent data like the risk-free rate, market risk premium, dividend on preferred stock, yield to maturity on debt, and the tax rate. To calculate WACC, we need to determine the cost of equity, the cost of preferred stock, and the after-tax cost of debt, and then weight them by their respective proportions in the company's overall capital structure.
Cost of equity (Re) can be calculated using the Capital Asset Pricing Model (CAPM). CAPM formula is Re = Rf + (Beta * (Market Risk Premium)), which in this case is 3% + (1.2 * 8%) = 12.6%. Cost of preferred stock (Rp) is the dividend divided by the price of the preferred stock, so $5 / $25 = 20%. The after-tax cost of debt (Rd) is the yield to maturity times (1 - tax rate), which is 8.5% * (1 - 25%) = 6.375%.
Now, we use the market values to weight these costs: The equity portion (We) is $7 billion out of $22 billion total capital, the preferred stock portion (Wp) is $4 billion out of $22 billion, and the debt portion (Wd) is $11 billion out of $22 billion. Using these weights, we compute WACC = (We * Re) + (Wp * Rp) + (Wd * Rd), which leads to WACC = ($7 billion/$22 billion * 12.6%) + ($4 billion/$22 billion * 20%) + ($11 billion/$22 billion * 6.375%) = 9.75%.
Hence, the correct answer for Ford's weighted average cost of capital is 9.75%, which corresponds to option D.