Pfd Company has debt with a yield to maturity of 7.5%, a cost of equity of 13.5%, and a cost of preferred stock of 9.5%. The market values of its debt, preferred stock, and equity are $10.5 million, $3.5 million, and $24.5 million, respectively, and its tax rate is 40%. What is this firm's weighted average cost of capital (WACC)?
Answer:
10.68%
Step-by-step explanation:
As we know that:
WACC = Ke * Ve / (Ve + Vpref + Vd (1-Tax))
+ Kd * Vd*(1-tax) / (Ve + Vpref + Vd*(1-Tax))
+ Kpref * Vpref / (Ve + Vpref + Vd (1-Tax))
Here
Ke is 13.5%
Pre tax Kd is 7.5%
Kpref is 9.5%
Ve is value of equity and is $24.5 million
Vpref is value of equity $3.5 million
Vd is $10.5 million
Tax rate is 40%
By putting the values, we have:
WACC = 13.5% *$24.5 / ($24.5m + $3.5m + $10.5m (1-40%))
+ 7.5% * (1-40%) * $45m / ($24.5m + $3.5m + $10.5m (1-40%))
+ 9.5% * $3.5m / ($24.5m + $3.5m + $10.5m (1-40%))
WACC = 0.045 * 0.273 + 0.095 * 0.091 + 0.135 * 0.636
= 10.68%