Question

Ford Motor Company is discussing new ways to recapitalize the firm and raise additional capital. Its current capital structure has a 20​% weight in​ equity, 5​% in preferred​ stock, and 75​% in debt. The cost of equity capital is 12​%, the cost of preferred stock is 9​%, and the pretax cost of debt is 8​%. What is the weighted average cost of capital for Ford if its marginal tax rate is 35​%?

Answer 1

The WACC is 6.75%

Step-by-step explanation:

The weighted average cost of capital, also called WACC, is the cost of a firm's capital structure. The capital structure is made up of debt, preferred stock and common stock.

The formula for WACC is,

WACC = wD * rD * (1 - tax rate) + wP * rP + wE * rE

Where,

• w represents the weight of each component in the capital structure or value of each component as a proportion of total assets

• r represents the cost of each component

• we take after tax cost of debt. So we multiply cost of debt by (1 - tax rate)

The WACC is:

WACC = 0.75 * 0.08 * (1 - 0.35) + 0.05 * 0.09 + 0.20 * 0.12

WACC = 0.0675 or 6.75%