Question

Consider the WACC formula, if the required rate of return on preferred stock increases, holding all else equal, the WACC increases.
a) true
b) false

Answer 1

Answer: True

Explanation:

The Weighted Average Cost of Capital (WACC) calculates the cost of capital to a company for the means of capital it uses to finance operations. It is based on the cost and the weight of the various capital types.

Formula is;

= Cost of Equity * %Equity + Cost of debt * %Debt * ( 1 - Tax rate) + Cost of Preferred Stock * %Preferred stock

The required rate of return on preferred stock is the same as the Cost of Preferred Stock. From the formula it is shown that if this rate increases, holding all else equal, total WACC will increase.