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Up2
The market values of a firm’s capital are given below:
Total debt: $7 millionOutstanding preferred stock: $2 millionOutstanding common stock: $12 millionIts 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%
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Up3
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%
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Up2
Woo! I got it right! 🙂
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