Final answer:
The weighted average cost of capital (WACC) for a firm is calculated using the proportions of debt, equity, and preferred stock, along with their respective costs and the corporate tax rate. In this example, considering a capital structure of 60% debt, 30% equity, and 10% preferred stock, along with the given costs and tax rate, the WACC is found to be 8.82%.
Step-by-step explanation:
The student is asking about the weighted average cost of capital (WACC), which is a calculation of a firm's cost of capital in which each category of capital is proportionately weighted. To solve for WACC, one must use the formula: WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc) + (P/V) * Rp, where:
- E = Market value of the equity (common stock).
- V = Total market value of the firm (debt + equity + preferred stock).
- Re = Cost of equity.
- D = Market value of the debt.
- Rd = Cost of debt.
- Tc = Corporate tax rate.
- P = Market value of the preferred stock.
- Rp = Cost of preferred stock, which is the dividend divided by the price of the preferred stock.
In this scenario, the cost of preferred stock (Rp) would be $6 / $50 = 0.12 or 12%. Considering the firm's capital structure of 60% debt, 30% equity, and 10% preferred stock, and applying the tax shield on debt, the WACC can be calculated as follows:
WACC = (0.3 * 0.15) + (0.6 * 0.08 * (1 - 0.35)) + (0.1 * 0.12) = 0.045 + 0.0312 + 0.012 = 0.0882 or 8.82%.
Therefore, the correct answer is (b) 8.82%.