Question

Calculate the weighted average cost of capital for the following firm: it has $275,000 in debt, $650,000 in common stock and $115,000 in preferred stock. It has a 5.75% cost of debt, 9.75% cost of common stock, 12% cost of preferred stock and a 25% tax rate. 9.13% 6.75% 7.29% 8.56%

Answer 1

Answer:

WACC = 8.56%

Explanation:

First, we need to find out what is the equivalent percentage of every source of cash, I mean, if the sum of all sources is 1,040,000 (275,000+650,000+115,000) each source participation will be as follows.

Debt = 275000/1040000=26.44%

Common Stocks= 650000/1040000=62.50%

Preferred Stocks= 115000/1040000= 11.06%

Now, let's remember that common stocks and preferred stocks are not tax-deductible, on the other hand, the debt it is, so, the afer-tax cost of each source is:

Debt = 5.75% x (1-0.25) = 4.31%

Common Stocks = 9.75%

Preferred Stocks = 12%

Finally, our weighted average cost of capital is:

WACC = 4.31% x (26.44%) + 9.75% x (62.50%) + 12% x (11.06%) = 8.56%

Best of luck