Question

Which one of the following statements is correct concerning the weighted average cost of capital? (WACC)?

A.

The

pre?tax

rate of return on the debt is the rate that is relevant to the computation of the WACC.??

B.

When computing the? WACC, the weight assigned to the preferred stock is equal to the coupon rate multiplied by the par value assigned to the preferred stock.??

C.

The weight of the common stock used in the computation of the WACC is based on the number of shares outstanding multiplied by the book value per share.??

D.

The weight of the debt can be based on the face value of the bond? issue(s) outstanding multiplied by the quoted? price(s) when expressed as a percentage of the face value.

E.

A? firm's WACC will decrease as their corporate tax rate decreases.?

Answer 1

Answer:

options A is wrong:

Wrong Statement: The pre tax rate of return on the debt is the rate that is relevant to the computation of the WACC

Right Statement: while calculating WACC, after tax cost of debt is considered.

options B is wrong:

Wrong Statement: When computing the WACC, the weight assigned to the preferred stock is equal to the coupon rate multiplied by the par value assigned to the preferred stock.

Right Statement: the weight assigned to the preferred stock = (number of preferred shares issued * book value per share)/Total Capital

Total Capital = book value of common stock + book value of preferred stock + book value of debts + book value of retained earnings +book value of term loans

option C is wrong

Wrong Statement: The weight of the common stock used in the computation of the WACC is based on the number of shares outstanding multiplied by the book value per share.

Right Statement: The weight of the common stock used in the computation of the WACC = (number of shares outstanding multiplied by the book value per share)/Total Capital

Total Capital = book value of common stock + book value of preferred stock + book value of debts + book value of retained earnings +book value of term loans

options D is wrong:

Wrong Statement: The weight of the debt can be based on the face value of the bond issue(s) outstanding multiplied by the quoted? price(s) when expressed as a percentage of the face value.

Right Statement: The weight of the debt = book value of debts/Total Capital

Total Capital = book value of common stock + book value of preferred stock + book value of debts + book value of retained earnings +book value of term loans

option E is wrong

Wrong Statement: A firm's WACC will decrease as their corporate tax rate decreases.

Right Statement: A firm's WACC will decrease as their corporate tax rate increases

Dividends on common stock and preferred stock are paid from after tax profits, Interest on debts and loans are paid from profits before payment of taxes. So taxes will affect cost of debts and loans. After tax cost of debts and loans are taken into consideration while calculating WACC. The greater the tax rates, cost of debts and loans will be lower and vice versa.