Question

Consider the following information about Walter White Industries: They have $5 million in debt outstanding, book value of common stock is $10 million, market value of common stock is $20 million, market value of preferred stock is $3 million. Required returns are 7%, 12% and 19% for debt, preferred stock, and common stock, respectively. Tax rate is 38%. What is their weighted average cost of capital

Answer 1

Answer:

Weighted average cost of capital is 15.6%

Explanation:

Market Value Common Stock = $20 million

Market Value Preferred Share = $3 million

Value of Debt = $5 million

Total  = $20 + $3 + $5 = $28 million

WACC is the average cost of capital of the firm based on the weightage of the debt and weightage of the equity multiplied to their respective costs.

According to WACC formula

WACC = ( Cost of common stock x Weightage of common stock ) + ( Cost of preferred stock x Weightage of preferred stock ) + ( Cost of debt ( 1- t) x Weightage of debt )

WACC = ( 19% x 20/28 ) + ( 12% x 3/28 ) + ( 7% ( 1 - 0.38 ) x 5/28 )

WACC = 13.57% + 1.26% + 0.78% = 15.61%