Question

The market value of​ Fords' equity, preferred​ stock, and debt are $ 7 ​billion, $ 2 ​billion, and $ 15 ​billion, respectively. Ford has a beta of 1.2​, the market risk premium is 8​%, and the​ risk-free rate of interest is 4​%. ​ Ford's preferred stock pays a dividend of $ 3 each year and trades at a price of $ 25 per share. ​ Ford's debt trades with a yield to maturity of 8​%. What is​ Ford's weighted average cost of capital if its tax rate is 35​%?

Answer 1

Answer:

Ford's weighted average cost of capital is 8.22 %

Explanation:

Weighted Average Cost of Capital (WACC) is the minimum return that the company expect from a project. It shows the risk of the company.

Calculation of WACC

WACC = Cost of equity + Cost of preferred​ stock + Cost of debt

Capital Source       Market Values     Weight      Cost      Total Cost

equity                         $ 7 ​billion          29.17%      13.6%       3.97 %

preferred​ stock         $ 2 ​billion            8.33%      12%          1.00 %

debt                           $ 15 ​billion         62.50%     5.2 %       3.25%

Total                          $ 24 billion                                          8.22 %

Cost of equity = Risk free rate + Beta × Risk Premium

                       =  4% + 1.2 × 8%

                       =  13.6%

Cost of preferred​ stock = Dividend/Market Price

                                       = $ 3/ $ 25 × 100

                                       = 12%

Cost of debt = interest × (1- tax rate)

                    = 8% × (1-0.35)

                    = 5.2 %