Question

XYZ Company's weighted average cost of capital is 9%. If the weights and costs are as follows, what would be the cost of preferred stock?

Weights Cost:

Common Stock 35% 14%

Preferred Stock 15% ?

Debt 50% 9%

Tax rate 21%

Answer 1

Given about XYZ's company,

Weighted average cost of capital Kc = 9%

Weights are as follow:

Weight of debt Wd = 50%

Weight of Common stock We = 35%

weight of preferred stock Wp = 15%

Cost of debt Kd = 9%

Cost of common stock Ke = 14%

Let cost of preferred stock be Kp

Tax rate T = 21%

Weighted average cost of capital is calculated using formula

Kc = Wd*Kd*(1-T) + We*Ke + Wp*Kp

=> 9 = 0.5*9*(1-0.21) + 0.35*14 + 0.15*Kp

=> 9 = 3.555 + 4.9 + 0.15*Kp

=> Kp = 0.545/0.15

=> Kp = 3.63%

So, cost of preferred stock = 3.63%