Question

The market value of​ Fords' equity, preferred​ stock, and debt are $ 7 ​billion, $ 3 ​billion, and

$ 12 ​billion, respectively. Ford has a beta of 1.5

the market risk premium is 8​%,

and the​ risk-free rate of interest is 4​%.

​ Ford's preferred stock pays a dividend of $ 2

each year and trades at a price of $26

per share. ​ Ford's debt trades with a yield to maturity of 77​%.

What is​ Ford's weighted average cost of capital if its tax rate is 40​%?

Answer 1

Given about Ford,

Market value of equity = $7 billion

Market value of preferred stock = $3 million

Market value of debt = $12 billion

So, weight of equity We = Equity/(equity + preferred stock + debt) = 7/(7+3+12) = 0.3182

Weight of preferred stock Wp = Preferred stock/(equity + preferred stock + debt) = 3/(7+3+12) = 0.1364

Weight of debt Wd = Debt/(equity + preferred stock + debt) = 12/(7+3+12) = 0.5455

beta of 1.5

the market risk premium Rm = 8​%,

and the​ risk-free rate of interest Rf = 4​%

=> Cost of equity Ke using CAPM is

Ke = Rf + Beta*MRP = 4 + 1.5*8 = 16%

Ford's preferred stock pays a dividend of $2 each year and trades at a price of $26 per share

=> Cost of preferred Kp stock using perpetuity model is

Kp = D/P0 = 2/26 = 7.69%

Ford's debt trades with a yield to maturity of 7.7​%.

So, for a company, Its cost of Debt Kd equals its bond's YTM

=> Kd = 7.7%

Tax rate = 40%

So, Ford's weighted average cost of capital = Wd*Kd*(1-T) + Wp*Kp + We*Ke

=> WACC = 0.5455*7.7*(1-0.4) + 0.1364*7.69 + 0.3182*16 = 8.66%

So, Ford's weighted average cost of capital = 8.66%