Question

Assume the market value of Fords' equity, preferred stock, and debt are$6 billion, $2 billion, and $13 billion, respectively. Ford has a beta of 1.7, the market risk premium is 8%, and the risk-free rate of interest is 3%. Ford's preferred stock pays a dividend of $4 each year and trades at a price of $30 per share. Ford's debt trades with a yield to maturity of 8.0%. What is Ford's weighted average cost of capital if its tax rate is 30%?A) 9.95%B) 9.48%C) 10.43%D) 11.38%.

Answer 1

Answer:

Option (B) is correct.

Explanation:

cost of equity, Re = Risk free rate + equity rate × market risk premium

Re = 0.03 + (1.7 × 0.8)

     = 0.166R

cost of preferred stock, pfd = Dividend ÷ stock price

Rpfd = 4 ÷ 30

        = 0.1333

D% = 13 billion ÷ 21 billion

      = 0.619

E% = 6 billion ÷ 21 billion

     = 0.286

P% = 2 billion ÷ 21 billion

     = 0.095

Rd = debt capital comes from yield to maturity of 8% (YTM is an estimate of debt capital)

Tc= 30%

Rwacc =(w/ preferred stock)

           = Re × E% + Rpfd × P% + Rd(1-Tc)D%

Rwacc = (0.166)(0.286) + (0.1333)(0.095) + (0.08)(1-(0.3))(0.619)

           = 0.094803 ie 9.48%

Therefore, Ford's weighted average cost of capital if its tax rate is 30% is 9.48%.