Question

Calculate the weighted average cost of capital for the following firm: it has $600000 in debt, $400000 in common stock and $200000 in preferred stock. It has a 4% cost of debt, 14% cost of common stock, 12% cost of preferred stock and a 34% tax rate.

Answer 1

7.99%

Working:

a.	After tax cost of debt			=	Before Tax cost of debt *(1-Tax Rate)
				=	4%*(1-0.34)
				=	2.64%
b.	Total amount of Capital:
	Debt			$          6,00,000
	Common Stock			$          4,00,000
	Preferred Stock			$          2,00,000
	Total			$       12,00,000
c.	Weight of:
	Debt			$          6,00,000	/	$ 12,00,000	=	0.50
	Common Stock			$          4,00,000	/	$ 12,00,000	=	0.33
	Preferred Stock			$          2,00,000	/	$ 12,00,000	=	0.17
				Total				1.00
d.	Weighted Average Cost of Capital;
	Capital			Weight	Cost	Weighted Cost
	Debt	(After tax)		0.50	2.64%	1.32%
	Common Stock			0.33	14.00%	4.67%
	Preferred Stock			0.17	12.00%	2.00%
			Total			7.99%