Question

Assume the market value of Fords' equity, preferred stock and debt are $7 billion, $4 billion and $10 billion respectively. Ford has a beta of 1.4, the market risk premium is 6% 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 $25 per share. Ford's debt trades with a yield to maturity of 8.5%. What is Ford's weighted average cost of capital if its tax rate is 35%?

A) 7.69%

B) 8.15%

C) 8.60%

D) 9.05%

Answer 1

Total Capital = Equity + preferred Stock + Debt

= 7 Billion + 4 Billion + 10 billion

= 21 billion

Cost of Equtiy = Rf + Beta (Rm - Rf)

= 4% + 1.4 (6%)

= 12.4%

Cost of Preferred Stock = Dividend / Value of Preferred Stock

= 3 / 25

= 12%

Cost of Debt = 8.5%

WACC = (Cost of Equity * Weight of Equity) + (Cost of Debt after tax * Weight of Debt) + (Cost of Preferred Stock * Cost of Preferred Stock)

= 12.4% * 7 / 21 + 8.5% (1-0.35) * 10 / 21 + 12% * 4 /21

= 4.13333333333% + 2.63095238095% + 2.28571428571%

= 9.05%

Option D is correct.