Use the following information to calculate the firm’s weighted average cost of c
ID: 2792065 • Letter: U
Question
Use the following information to calculate the firm’s weighted average cost of capital:
The dividend for preferred shares is $5, and the current price for preferred stock is $75.
The rate of return on long-term debt is 6%, the rate of return on short-term debt is 5%, and the marginal tax rate is 35%.
The market risk premium is 5%, the risk-free rate is 3%, and the firm has a beta of 0.9.
The firm’s capital structure is as follows: long-term debt is 25%, short-term debt is 4%, preferred stock is 2%, and common stock is 69%.
Explanation / Answer
After tax long term interest rate = 0.06 * (1 - 0.35) = 0.039
After tax short term interest rate = 0.05 * (1 - 0.35) = 0.0325
Cost of equity = risk free rate + beta * (market risk premium)
Cost of equity = 0.03 + 0.9 (0.05)
Cost of equity = 0.03 + 0.045
Cost of equity = 0.075
rate of return of preferred stock = 5/75 = 0.0667
WACC = 0.25 * 0.039 + 0.04 * 0.0325 + 0.02 * 0.0667 + 0.69 * 0.075
WACC = 0.00975 + 0.0013 + 0.001334 + 0.05175
WACC = 0.064
WACC = 6.4%