The market values of a firm’s capital are given below: Total debt: $7 million Outstanding preferred stock: $2 million Outstanding common stock: $12 million Its before-tax cost of debt is 8%, cost of common equity is 12% and cost of preferred stock is 9%. Assuming company’s marginal tax rate is 35%, what is the weighted average cost of capital (WACC) for the firm?10.40%10%9.50%

Correct Answer: CWeight of debt in the firm’s capital structure = 7/ (7 + 2 + 12) = 33.3%Weight of preferred stock in the firm’s capital structure = 2/ (7 + 2 + 12) = 9.5%Weight of common stock in the firm’s capital structure = 12/ (7 + 2 + 12) = 57.1%After-tax cost of debt = 8*(1-0.35) = 5.2%WACC = (weight of debt*cost of debt) (weight of preferred stock*cost of preferred stock) (weight of equity*cost of equity) = 0.333*0.052 + 0.095*0.09 + 0.571*0.12 = 9.5%

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This topic has 2 replies, 2 voices, and was last updated Jan-188:42 pm by shannondaily.

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- exam_whiz
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  27 Nov 2017 at 8:24 am
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  Correct Answer: C
  
  Weight of debt in the firm’s capital structure = 7/ (7 + 2 + 12) = 33.3%
  
  Weight of preferred stock in the firm’s capital structure = 2/ (7 + 2 + 12) = 9.5%
  
  Weight of common stock in the firm’s capital structure = 12/ (7 + 2 + 12) = 57.1%
  
  After-tax cost of debt = 8*(1-0.35) = 5.2%
  
  WACC = (weight of debt*cost of debt) (weight of preferred stock*cost of preferred stock) (weight of equity*cost of equity) = 0.333*0.052 + 0.095*0.09 + 0.571*0.12 = 9.5%
- shannondaily
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  25 Jan 2018 at 8:42 pm
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  Woo! I got it right! 🙂
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