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 45% debt, 50% common equity, and 5% preferred stock. Credit Rating BB+
What is the firm's Weighted Average Cost of Capital (WACC)?
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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
= .45(6%) + .5(12%) + .05(10.25%) = 9.21%