Question

The market value of​ Fords' equity, preferred​ stock, and debt are

$ 8$8

​billion,

$ 1$1

​billion, and

$ 15$15

​billion, respectively. Ford has a beta of

1.31.3​,

the market risk premium is

88​%,

and the​ risk-free rate of interest is

44​%.

​ Ford's preferred stock pays a dividend of

$ 3$3

each year and trades at a price of

$ 28$28

per share. ​ Ford's debt trades with a yield to maturity of

8.58.5​%.

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

3535​%?

A.

9.579.57​%

B.

10.4410.44​%

C.

9.139.13​%

D.

8.78.7​%

Answer 1

Cost of equity = Risk-free rate + Beta(Market risk premium)

Cost of equity = 0.04 + 1.3(0.08)

Cost of equity = 0.144 or 14.4%

Cost of preferred stock = Dividend / Price = $3 / $28 = 0.10714 or 10.714%

WACC = (Weight of common stock * Cost of common equity) + (Weight of preferred stock * Cost of preferred stock) + [Weight of debt * Pretax cost of debt(1 - Tax)]

WACC = [($8 ​billion/$24 billion) * 0.144] + [($1 ​billion/$24 billion) * 0.10714] + [($15 ​billion/$24 billion) * 0.085(1 - 0.35)]

WACC = 0.087 or 8.7​%