Question

Testbank, Question 14 A firm has a capital structure that uses 45 percent equity, 20 percent preferred shares, and 35 percent debt. The preferred shares have a current yield of 5.5 percent. The debt has a coupon rate of 10 percent and a current yield to maturity of 6.5 percent. The common shares have a yield of 8 percent. The tax rate is 25 percent. What is the firm’s WACC? 5.231% 6.700% 6.406% 6.975%

Answer 1

Information provided:

Weight of equity= 45%

Weight of preference shares= 20%

Weight of debt= 35%

Yield of common shares= 8%

Yield of preference shares= 5.50%

Yield to maturity= 6.5%

Tax rate= 25%

The weighted average cost of capital is calculated using the below formula:

WACC=Wd*Kd(1-t)+Wps*Kps+We*Ke

where:

Wd= Percentage of debt in the capital structure.

Kd= The before tax cost of debt

Wps= Percentage of preferred stock in the capital structure

Kps=Cost of preferred stock

We=Percentage of equity in the capital structure

Ke= The cost of common equity.

T= Tax rate

WACC= 0.35*6.50%*(1 – 0.25) + 0.20*5.50% + 0.45*8%

            = 1.7063 + 1.10 + 3.60

            = 6.4063%

Hence the answer is option b.

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