Question

(RWJ Essentials 5ed Ch12 Problem9) [Calculating WACC] A company has a target capital structure of 50% common stock, 5% preferred stock, and 45% debt. Its cost of equity is 14%, the cost of preferred stock is 6%, and the cost of debt is 7.5%. The relevant tax rate is 35%. What is WACC of the firm ? The company president has approached you about capital structure of the firm. He wants to know why the company doesn't use more preferred stock financing, since it costs less than debt. What would you tell the president?

Answer 1

WACC = (0.5 x 0.14) + (0.05 x 0.06) + (0.45 x 0.075 x (1 - 0.35))

WACC = 0.07 or 7%

Therefore, the WACC of the firm is 7%.