Question

A company has a capital structure that includes 30% debts, 10% preferred stock, and 60% common stock. The before-tax cost of debt is 11%. The cost of preferred stock is 10.3%. The cost of common stock is 14.7%. New common stock sales cost approximately 16%. The marginal tax rate is 40% According to the above information, what is the weighted average cost of capital for this company?
A) 10.3%
B) 11%
C) 11.8%
D) None of the above

Answer 1

Answer:

option (C) 11.8%

Explanation:

Debts = 30%

Preferred stock = 10%

Common stock = 60%

before-tax cost of debt = 11%

cost of preferred stock = 10.3%

cost of common stock = 14.7%

New common stock sales cost = 16%

The weighted average cost of capital for the company

marginal tax rate = 40%

= Debt × before-tax cost of debt × (1 - tax)) + (Common stock × cost of common stock ) + (Preferred stock × cost of preferred stock )

= 0.30 × 0.11 × (1 - 0.40) + (0.60 × 0.147 ) + ( 0.10 × 0.103 )

= 0.0198 + 0.0882 + 0.0103

= 0.1183

Or

= 0.1183 × 100% = 11.83% ≈ 11.8%

Hence.

The correct answer is option (C) 11.8%