Question

Rogue Rotors has debt with a market value of​ $350,000, preferred stock with a market value of​ $100,000, and common stock with a market value of​ $650,000. If debt has a cost of​ 7%, preferred stock a cost of​ 9%, common stock a cost of​ 13%, and the firm has a tax rate of​ 30%, what is the​ WACC?

Answer 1

Solution:

As per the information given in the question

Market Value of debt = $ 350,000                

Market Value of Preferred Stock = $ 100,000

Market Value of Common Stock = $ 650,000

Total Market value of the Securities = $ 350,000 + $ 100,000 + $ 650,000 = $ 11,000,000

Thus Weight of Debt = [ Market value of debt / Total market value of all the securities ]

= $ 350,000 / $ 11,000,000 = 0.318182

Thus Weight of Preferred Stock = [ Market value of Preferred Stock / Total market value of all the securities ]

= $ 1000,000 / $ 11,000,000 = 0.090909

Thus Weight of Common Stock = [ Market value of Common Stock / Total market value of all the securities ]

= $ 650,000 / $ 11,000,000 = 0.590909

The formula for calculating the weighted average cost of capital is =

WACC = [ K_D * ( 1 – t ) * W_D ] + [ K_P * W_P ] + [ K_C * W_C ]

where

K_D = Cost of debt    ; t = Income tax rate ; W_D = Weight of debt ;

K_P = Cost of Preferred Stock ; W_P = Weight of preferred stock    ;  

K_C = Cost of Common Stock     ;    W_C = Weight of common stock

As per the information available in the question we have

K_D = 7 %     ; t = 30 % = 0.30 ; W_D = 0.318182 ; K_P = 9 % ;    W_P = 0.090909    ;  

K_C = 13 %    ;    W_C = 0.590909

Applying the above values in the formula we have

= [ ( 7 % * ( 1 – 0.30 ) * 0.318182 ) + ( 9 % * 0.090909 ) + ( 13 % * 0.590909 ) ]

= [ ( 7 % * 0.70 * 0.318182 ) + ( 9 % * 0.090909 ) + ( 13 % * 0.590909 ) ]

= [ 1.559092 % + 0.818181 % + 7.681817 % ]

= 10.059090 %

= 10.06 % ( when rounded off to two decimal places )

Thus the weighted average cost of capital (WACC) of Rogue Rotors is 10.06 %