Question

The Yorkshire Dairy Corp. has a target capital structure of 20% debt, 25% preferred stock, and 55% common equity. The company's after-tax cost of debt is 6%, its cost of preferred stock is 10%, its cost of internal common equity, i.e., retained earnings, is 14%, and its cost of new common stock is 17.5%. The company's marginal tax rate is 30%. If new common stock is used to fund the common equity portion of the company's capital, what is its weighted average cost of capital? Answer in %, i.e., if your answer is 10.3%, type 10.3 as the answer. Round to the nearest 0.1%.

Answer 1

The WACC is 13.3

Step-by-step explanation:

The WACC or weighted average cost of capital is the cost of a firm's capital structure. The capital structure of a firm can contain three components namely debt, common stock and preferred stock.

We use the market value of each component of capital structure to calculate the WACC. 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
• r represents the cost of each component
• We take the after tax cost of debt. Thus we multiply the cost of debt by (1 - tax rate)

WACC = 0.2 * 0.06 + 0.25 * 0.1 + 0.55 * 0.175

WACC = 0.13325 or 13.325% rounded off to 13.3