-Question Help * (Related to Checkpoint 14.1) (Weighted average cost of capital)

Question

-Question Help * (Related to Checkpoint 14.1) (Weighted average cost of capital) The target capital structure for QM Industries is 35 percent common stock, 15 percent preferred stock, and 50 percent debt If the cost of common equity for the firm is 17.8 percent, the cost of preferred stock is 10.6 percent, the before-tax cost of debt is 8.1 percent, and the firm's tax rate is 35 percent, what is QM's weighted average cost of capital? QM's weighted average cost of capital is | |%. (Round to three decimal places.)

Explanation / Answer

Solution :

Target Capital Structure is

Common Stock = 35%

Preffered stock = 15%

Debt = 50%

Cost associated with each type of funds are

Common stock = 17.8%

Preffered Stock = 10.6%

Debt (Pre-tax)= 8.1%, tax rate = 35% ,

After tax cost of debt = Pre-tax cost of debt * (1 - Tax rate) = 8.1% * (1- 35% ) = 8.1% * 65% =

WACC is the weighted average cost of capital and it is calculated as

WACC = Cost of equity * weight of equity + cost of preffered share * weight of preffered share + cost of debt * weight of debt

WACC = 17.8% * 0.35 + 10.6% * 0.15 + 5.265%*0.50

WACC = 6.23% + 1.59% + 2.6325 = 10.4525 % = 10.45%

Weighted average cost of capital is 10.45%

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