Question

A firm has 50% common stock, 5% preferred stock, and 45% debt. The cost of equity is 10 percent, a cost of preferred of 9 percent, and an after tax cost of debt of 5 percent. Given this, what is the firm's weighted average cost of capital?

Answer 1

The firm's weighted average cost of capital (WACC) is calculated using the weights of each capital component and their respective costs. Considering the given weights and costs, the WACC for the firm is found to be 7.7 percent.

Step-by-step explanation:

To calculate the firm's weighted average cost of capital (WACC), we multiply each cost of capital by its respective weighting and then sum the results. The formula for WACC is:

WACC = (E/V) * Re + (P/V) * Rp + (D/V) * Rd * (1 - Tc)

Where:

• E = Market value of equity
• P = Market value of preferred stock
• D = Market value of debt
• V = E + P + D = Total market value of the firm's financing (equity + preferred stock + debt)
• Re = Cost of equity
• Rp = Cost of preferred stock
• Rd = Cost of debt
• Tc = Corporate tax rate

Based on the provided percentages and costs, the calculation is:

WACC = (0.50 * 10%) + (0.05 * 9%) + (0.45 * 5% * (1 - 0))

WACC = (0.50 * 0.10) + (0.05 * 0.09) + (0.45 * 0.05)

WACC = 0.05 + 0.0045 + 0.0225

WACC = 0.077 or 7.7%

Therefore, the firm's WACC is 7.7 percent.