The capital structure contains 25% debt, 20% preferred stock, and 55% common equity. the interest rate on new debt is 6.50%. the preferred stock yields 6.00%. the cost of retained earnings is 12.00%, this company pays tax at the rate of 40%. there will be no issue of any new stock. calculate the wacc.
Answers
Answer: Weighted average cost of capital is 8.775%
Explanation:
Weighted Average Cost of capital is the cost of capital by weighted average of each source of capital.
There are different sources of capital:
1. Debt
2. Preferred Stock
3. Common Stock
Using the information in the question, the
Weight of debt(Wd): 25%
Weight of Preferred Stock (Wp): 20%
Weight of Common Stock (We): 55%
The cost of each source of capital is as follows:
Post tax cost of debt = Pre Tax cost of debt × (1 - tax rate)
where, Pretax cost of debt = 6.50%
Tax rate = 40%
Cost of Preferred stock = 6%
Cost of common equity = 12%
Weighted Average cost of capital = Wd × Post tax cost of debt + Wp × Cost of preferred stock + We × Cost of common equity
Weighted Average cost of capital (WACC) = 0.25 × 3.90% + 0.20 × 6% + 0.55 × 12%
Weighted Average Cost of capital (WACC) = 8.775%
Therefore, the weighted average cost of capital is 8.775%