Question

cost of debt = 5%; cost of preferred = 8%; cost of equity = 10%. What us the weighted average cost of capital? (assume the tax rates 0%).

market value

debt. $10 million

preferred $3 million

equity. $27 million

A. 9.4%

B. 8.6%

C. 7.5%

D. 6.4%

E. None of these

Answer 1

cost of debt Kd = 5%

cost of preferred Kp = 8%

cost of equity Ke = 10%

Tax rate T = 0

market value

debt. $10 million

preferred $3 million

equity. $27 million

=> weight of debt Wd = debt/(debt + preferred + equity) = 10/(10+3+27) = 25%

Weight of preferred Wp = preferred/(debt + preferred + equity) = 3/(10+3+27) = 7.5%

Weight of equity We = equity/(debt + preferred + equity) = 27/(10+3+27) = 67.5%

So, weighted average cost of capital, WACC = Wd*Kd*(1-T) + Wp*Kp + We*Ke

=> WACC = 0.25*5*(1-0) + 0.075*8 + 0.675*10 = 8.60%

Option B is correct.