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%.

Answer 1

Preferred Stock:

Weight of Preferred Stock = 2%

Cost of Preferred Stock = Annual Dividend / Current Price
Cost of Preferred Stock = $5 / $75
Cost of Preferred Stock = 6.67%

Short-term Debt:

Weight of Short-term Debt = 4%

After-tax Cost of Short-term Debt = 5%*(1-0.35)
After-tax Cost of Short-term Debt = 3.25%

Long-term Debt:

Weight of Long-term Debt = 25%

After-tax Cost of Long-term Debt = 6%*(1-0.35)
After-tax Cost of Long-term Debt = 3.90%

Common Stock:

Weight of Common Stock = 69%

Cost of Common Stock = Risk-free Rate + beta * Market Risk Premium
Cost of Common Stock = 3% + 0.90 * 5%
Cost of Common Stock = 7.50%

WACC = 2% * 6.67% + 4% * 3.25% + 25% * 3.90% + 69% * 7.50%
WACC = 6.41%

So, WACC of this firm is 6.41%