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

1.

Cost of preferred stock=Dividend/Price=5/75=6.67%

2

We dont include short term debt in WACC caluclations

After tax cost of long term debt=6%*(1-35%)=3.9%

After tax cost of short term debt=5%*(1-35%)=3.25%

3

Cost of equity=risk free+beta*market risk premium=3%+0.9*5%=7.5%

4

WACC=0.25/0.96*3.9%+0.02/0.96*6.67%+0.69/0.96*7.5%=6.5452%

If the question setter considers short term debt in WACC caluclations,

WACC=0.25*3.9%+0.04*3.25%+0.02*6.67%+0.69*7.5%=6.4134%

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