Weighted Average Cost of Capital (WACC)

Calculation for Optimal Capital Structure

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Question

Consider the following information:

Borrowing Rate 10%

Marginal Tax Rate 40%

Preferred Stock Par Price $100 -

Preferred Dividend $10 -

Preferred Stock floatation cost 2.5%

Cost of common equity 12.0%

Preferred Stock issued at Par -

The Optimal Capital Structure is 40% debt, 50% common equity, and 10% preferred stock. Credit Rating BB+ What is the firm's Weighted Average Cost of Capital

(WACC)?

Answers

Explanations

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A. B. C. D. E. F.

Explanation

The firm's Weighted Average Cost of Capital (WACC) is a weighted average of the component cost of capital. In this case 10%(borrowing rate) x (1-.4)Tax savings

= 6% is the component cost of debt. $10 (preferred dividend) / 97.5(Par minus floatation cost) = 10.25% is the component cost of preferred stock. Thus the WACC

= .4(6%) + .5(12%) + .1(10.25%) = 9.42%

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