Use the following information to calculate the firm’s weighted average cost of c

Question

Use the following information to calculate the firm’s weighted average cost of capital: a. The dividend for preferred shares is $5, and the current price for preferred stock is $75. b. The rate of return on long-term debt is 6%, the rate of return on short-term debt is 5%, and the marginal tax rate is 35%. c. The market risk premium is 5%, the risk-free rate is 3%, and the firm has a beta of 0.9. d. The firm’s capital structure is as follows: long-term debt is 25%, short-term debt is 4%, preferred stock is 2%, and common stock is 69%.

Explanation / Answer

Cost of preferred stock = 5/75 = 6.67%

Cost of equity = risk free rate + beta*market risk premium

cost of equity = 3% + 0.9*5% = 7.5%

WACC = rD (1- Tc )*( D / V )+ rE *( E / V )

Where...

rD = The required return of the firm's Debt financing
(1-Tc) = The Tax adjustment for interest expense
(D/V) = (Debt/Total Value)
rE= the firm's cost of equity
(E/V) = (Equity/Total Value)

WACC = 0.25*0.06*(1-0.35) + 0.04*0.05*(1-0.35) + 0.02*0.067 + 0.69*0.075 = 0.0641 = 6.41%

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