Question

The market value of common stock of a firm is $400 million. The market value of preferred stock is $60 million. The market value of debt is $140 million. The yield to maturity of debt is 5.8% and the dividend yield for the preferred stock is 7.2%. The required rate of return for common stock is 12%. The tax rate is zero.

What is the weighted average cost of capital for the firm?

Answer 1

The weighted average cost of capital (WACC) is the average cost of all the capital the company has raised to fund its operations, taking into account the relative weight of each source of capital. It can be calculated as follows:

WACC = (E/V x Re) + (P/V x Rp) + (D/V x Rd x (1-Tc))

where:

E = market value of common stock
P = market value of preferred stock
D = market value of debt
V = total market value of the firm (E + P + D)
Re = required rate of return on common stock
Rp = dividend yield on preferred stock
Rd = yield to maturity on debt
Tc = corporate tax rate (assumed to be zero in this case)

Plugging in the given values, we get:

WACC = [(400/600 x 0.12) + (60/600 x 0.072) + (140/600 x 0.058)] x (1-0)
= (0.08 + 0.018 + 0.013) x 1
= 0.109 or 10.9%

Therefore, the weighted average cost of capital for the firm is 10.9%.

Therefore, the weighted average cost of capital for the firm is 10.9%.