Question

The market value of​ Fords' equity, preferred stock and debt are $ 6 ​billion, $ 2 ​billion, and $ 12 ​billion, respectively. Ford has a beta of 1.8​, the market risk premium is 8​%, and the​ risk-free rate of interest is 4​%. ​ Ford's preferred stock pays a dividend of $ 2.50 each year and trades at a price of $ 25 per share. ​ Ford's debt trades with a yield to maturity of 10​%. What is​ Ford's weighted average cost of capital if its tax rate is 40​%?

Answer 1

Answer:

10.12 %

Explanation:

Weighted Average Cost of Capital (WACC) is the cost of permanent sources of capital pooled together. It shows the risk of the business and is used to evaluate projects.

WACC = Cost of equity x Weight of Equity + Cost of Debt x Weight of Debt + Cost of Preference Stock x Weight of Preference Stock

Remember to use the After tax cost of debt :

After tax cost of debt = Interest x (1 - tax rate)

                                    = 10​% x ( 1 - 0.40)

                                    = 6.00 %

Cost of equity :

Cost of equity = Return from Risk free security + Beta x Risk Premium

                        = 4.00 % + 1.8 x 8.00%

                        = 18.40 %

Cost of Preference Stock :

Cost of Preference Stock  = Dividend / Market return x 100

                                            = $2.50 / $ 25 x 100

                                            = 10%

therefore,

WACC = 18.40 % x 30 % + 6.00 % x 60 % + 10.00% x 10%

           = 10.12 %

thus,

Ford's weighted average cost of capital is 10.12 %