Question

The market value of​ Fords' equity, preferred​ stock, and debt are $ 7 ​billion, $ 3 ​billion, and $ 11 ​billion, respectively. Ford has a beta of 1.4​, the market risk premium is 8​%, and the​ risk-free rate of interest is 4​%. ​ Ford's preferred stock pays a dividend of $ 3 each year and trades at a price of $ 28 per share. ​ Ford's debt trades with a yield to maturity of 7.5​%.

What is​ Ford's weighted average cost of capital if its tax rate is 40​%?

A. 10.75​%

B. 9.85​%

C. 9.4​%

D. 8.95​%

Answer 1

Market value of equity is $7 ​billion
Market value of preferred​ stock is $3 ​billion
Market value of debt is $11 billion
Total value=$7 billion + $3 billion + $11 billion =$21 billion

Weight of equity=(Market value of equity)/(Total value)
=(7)/(21)=0.333333333
Weight of preferred​ stock=(Market value of preferred​ stock)/(Total value)
=(3)/(21)=0.142857143
Weight of debt=(Market value of debt)/(Total value)
=(11)/(21)=0.523809524

Cost of equity =Risk free rate + Beta*Market risk premium=4​% + 1.4*8​%
=4​% + 0.112
=0.152
Cost of preferred stock =(Dividend paid)/(Share price)=3/28=0.107142857
After tax cost of debt = (Yield to maturity)*(1-tax rate)
= (7.5​%)*(1-40​%)
=(7.5​%)*0.6
=0.045

WACC=Weight of equity*Cost of equity + Weight of Preferred Stock*Cost of Preferred Stock + Weight of Debt*After tax cost of debt
=0.33333333*0.152 + 0.142857143*0.107142857 + 0.523809524*0.045
=0.050666666+0.015306122+0.023571429
=0.089544217 or 8.95% (Rounded to 2 decimal places)

Answer: 8.95%