Question

The market value of​ Fords' equity, preferred​ stock, and debt are $ 7 ​billion, $ 2 ​billion, and $ 13 ​billion, respectively. Ford has a beta of 1.6​, the market risk premium is 8​%, and the​ risk-free rate of interest is 3​%. ​ Ford's preferred stock pays a dividend of $ 2 each year and trades at a price of $ 26 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 30​%?

Answer 1

Answer:

WACC is 9%

Explanation:

WACC is the average cost of capital of the firm based on the weightage of the debt and weightage of the equity multiplied to their respective costs.

According to WACC formula

WACC = ( Cost of equity x Weightage of equity ) + ( Cost of debt ( 1- t) x Weightage of debt ) + ( Cost of Preferred equity x Weightage of Preferred equity )

As per given data

Market Values

Equity = $7 ​billion,

Preferred​ stock = $2 ​billion

Debt = $13 ​billion

Cost

Equity

Capital asset pricing model measure the expected return on an asset or investment. it is considered as the cost of common stock.

Formula for CAPM

Cost of Equity = Risk free rate + beta ( market return - risk free rate )

Cost of Equity = Rf + β ( Mrp )

Cost of Equity = 3% + 1.6 ( 8% ) = 15.8%

Preferred​ stock = $2 / $26 = 0.077 = 7.7%

Debt = 8%

Placing values in the formula

WACC = ( 15.8% x $7 billion / $22 billion ) + ( 8% ( 1- 0.3) x $13 billion / $22 billion ) + ( 7.7% x $2 billion / $22 billion )

WACC = 5.03% + 3.31% + 0.7% = 9.04%