Answer:
To calculate the WACC, we need to first calculate the cost of each type of funding source, and then calculate the weighted average of those costs based on their respective weights in the company's capital structure.
Cost of Debt (Bonds):
The cost of debt is calculated using the formula:
Cost of Debt = (Interest Rate x (1 - Tax Rate))
= (8.5% x (1 - 30%))
= 5.95%
Cost of Preferred Shares:
The cost of preferred shares is calculated using the formula:
Cost of Preferred Shares = Dividend Yield
= 11.0%
Cost of Equity:
The cost of equity is calculated using the Capital Asset Pricing Model (CAPM) as follows:
Cost of Equity = Risk-Free Rate + Beta x (Market Return - Risk-Free Rate)
= 4.0% + 3.05 x (12.0% - 4.0%)
= 4.0% + 24.45%
= 28.45%
Weighted Average Cost of Capital (WACC):
WACC = (Weight of Debt x Cost of Debt) + (Weight of Preferred Shares x Cost of Preferred Shares) + (Weight of Equity x Cost of Equity)
= (1,000 / 1,800) x 5.95% + (400 / 1,800) x 11.0% + (1,400 / 1,800) x 28.45%
= 0.3308 x 5.95% + 0.2222 x 11.0% + 0.7778 x 28.45%
= 1.965% + 2.444% + 22.121%
= 26.53%
Therefore, the WACC for the company is 26.53%