Question

The market value of​ Fords' equity, preferred stock and debt are $7 billion, $1 billion, and $10 billion, respectively.

Ford has a beta of 1.8​, the market risk premium is 7​%, and the​ risk-free rate of interest is 3​%. Ford's preferred stock pays a dividend of $4.50 each year and trades at a price of $26 per share. Ford's debt trades with a yield to maturity of 9.5​%.

What is​ Ford's weighted average cost of capital if its tax rate is 30​%?

A. 10.72%

B. 12.87%

C. 11.26%

D. 11.79%

Answer 1

WACC = weight of equity * cost of equity + weight of preferred stock * cost of preferred stock + weight of debt * cost of debt after tax

weight od equity = Amount of equity / ( equity +preferred stock + debt amount) = $ 7 billions / ( $ 7+ 1 + 10 billions) = 7/18

Weight of preferred stock = 1/18

weight of debt = 10 / 18.

Cost of equity = Risk free rate + Beta * market risk premium = 3% * 1.8 * 7% = 15.6%

Cost of preferred stock = preferred dividend / preferred stock price = 4.50 / 26 = 17.30769230769%

Cost of debt after tax = yield of debt * ( 1 - tax rate ) = 9.5% * ( 1 -0.30) = 6.65%

WACC =(7/18) * 15.6% + (1 / 18) * 17.30769230769% + (10/18) * 6.65%

WACC = 10.7226495726%

WACC = 10.72%

Option A is correct.