Question

1. Assume the market value of a firm's preferred stock, equity, and debt are$2 billion, $6 billion, and $13 billion, respectively. The firm has a beta of 1.7, the market return is 11%, and the risk-free rate of interest is 3%. The firm's preferred stock pays a dividend of $4 each year and trades at a price of $30 per share. The firm's debt trades with a yield to maturity of 8.0%. What is the firm's weighted average cost of capital if its tax rate is 30%?

   	A.	11.38%
   	B.	9.95%
   	C.	10.43%
   	D.	9.48%

Answer 1

d. 9.48%

Cost of equity = Risk-free rate + Beta(Market return - Risk-free rate) = 0.03 + 1.7(0.11 - 0.03) = 0.166 or 16.6%

Cost of preferred stock = Dividend / Stock price = $4 / $30 = 0.1333 or 13.33%

Total value = $2 billion + $6 billion + $13 billion = $21 billion

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 = [($6 billion/$21 billion) * 0.166] + [($2 billion/$21 billion) * 0.1333] + [($13 billion/$21 billion) * 0.08(1 - 0.30)]

WACC = 0.0948 or 9.48%