Question

Assume the market value of Fords' equity, preferred stock and debt are $7 billion, $4 billion and $10 billion respectively. Ford has a beta of 1.4, the market risk premium is 6% 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 8.5%. What is Ford's weighted average cost of capital if its tax rate is 35%

Answer 1

WACC = 9.1%

Step-by-step explanation:

The weighted Average cost of Capital(WACC) is the average cost of capital for the different sources of long-term capital available to a firm weighted according to the proportion each source of finance bears to the total capital in the pool.

cost of equity = Rf+ β×(Rm-Rf)

(Rm-Rf)= 6%, Rf- 4%, β- 1.4

=4% + (1.4×6%) = 12.4

Cost of preferred share = Dividend/price

= 3/25× 100= 12.0%

After tax cost of debt = Yield × (1-Tax rate) = 8.5%× (1-0.35)=5.53%

Type cost Market value Cost × Market Value

Equity 12.4% 7 0.868

Preferred 12% 4 0.48

Bond 5.53% 10 0.553

Total 21 1.901

WACC = 1.901 /21 × 100 =9.1%

WACC = 9.1%