Question

The market value of​ Fords' equity, preferred​ stock, and debt are $ 7 ​billion, $ 2 ​billion, and $ 15 ​billion, respectively. Ford has a beta of 1.2​, the market risk premium is 8​%, and the​ risk-free rate of interest is 4​%. ​ Ford's preferred stock pays a dividend of $ 3 each year and trades at a price of $ 25 per share. ​ Ford's debt trades with a yield to maturity of 8​%. What is​ Ford's weighted average cost of capital if its tax rate is 35​%?

Answer 1

Ford's weighted average cost of capital is 8.22 %

Step-by-step explanation:

Weighted Average Cost of Capital (WACC) is the minimum return that the company expect from a project. It shows the risk of the company.

Calculation of WACC

WACC = Cost of equity + Cost of preferred​ stock + Cost of debt

Capital Source Market Values Weight Cost Total Cost

equity $ 7 ​billion 29.17% 13.6% 3.97 %

preferred​ stock $ 2 ​billion 8.33% 12% 1.00 %

debt $ 15 ​billion 62.50% 5.2 % 3.25%

Total $ 24 billion 8.22 %

Cost of equity = Risk free rate + Beta × Risk Premium

= 4% + 1.2 × 8%

= 13.6%

Cost of preferred​ stock = Dividend/Market Price

= $ 3/ $ 25 × 100

= 12%

Cost of debt = interest × (1- tax rate)

= 8% × (1-0.35)

= 5.2 %