Question

The market value of​ Fords' equity, preferred​ stock, and debt are $ 7 ​billion, $ 2 ​billion, and $ 13 ​billion, respectively. Ford has a beta of 1.7​, the market risk premium is 8​%, and the​ risk-free rate of interest is 3​%. ​ Ford's preferred stock pays a dividend of $ 3 each year and trades at a price of $ 27 per share. ​ Ford's debt trades with a yield to maturity of 7​%. What is​ Ford's weighted average cost of capital if its tax rate is 35​%?

Answer 1

Answer: 9.48%

Explanation:

Given Data

Debts ;

$7 billion

$2 billion

$13 billion

Beta of Fords stock = Beta = 1.50

Market risk premium = Rp = 8.0%

Risk free rate of interest = Rf = 4.0%

Equity rate = 1.7

Market risk rate = 0.8

Risk free rate = 0.03

Therefore;

Cost of Equity ( Re ) = Risk free rate + equity rate × market risk premium

= 0.03 + (1.7 × 0.8)

= 0.166

Preferred Stock Cost ( PSC)= Dividend ÷ stock price

= 4 ÷ 30

= 0.1333

Total debt = 13 + 6 + 2 = 21 billion

D% = 13 billion ÷ 21 billion

= 0.619

E% = 6 billion ÷ 21 billion

= 0.286

P% = 2 billion ÷ 21 billion

= 0.095

RD = debt capital at 8% maturity rate

Tc= 30%

Rwac =(w/ preferred stock)

= Re × E% + PSC × P% + Rd ( 1- Tc) D%

Rwac = (0.166)(0.286) + (0.1333)(0.095) + (0.08)(1- 0.3)*(0.619)

= 0.094803 * 100

= 9.48%

At 30% tax rate Ford weighted average cost is 9.48%