WACC Calculation for a Company | CFA® Level 1 Exam Preparation

B

Step 1: Determine the after-tax cost of debt:

Theafter-tax cost of debt[kd(1 "" t)]is used to compute the weighted average cost of capital. It is the interest rate on new debt (kd) less the tax savings due to the deductibility of interest (kdt).

Here, we are given the inputs needed to calculate kd: n = 15*2 = 30, PMT = (1000*0.07)/2 = 35, FV = 1000, PV = -1047.46, compute I = 3.25, multiply by 2 =

6.50%.

Thus, kd(1 "" t) = 6.50% * (1 "" 0.35) =4.22%

Step 2: Determine the cost of preferred stock:

Preferred stock is a perpetuity that pays a fixed dividend (Dps) forever. Thecost of preferred stock (kps)= Dps/ Pnet where

Dps = preferred dividends.

Pnet = net issuingprice after deducting flotation costs.

Here, Dps= 0.08 * $35.00 = $2.80, so kps= Dps/ Pnet =$2.80 / $33.60 = 0.0833, or8.33%.

Step 3: Determine the cost of retained earnings:Given as 10.5%.

Step 4: Determine the cost of common equity:

Thecost of new common equityis given by:

ke= [D1/ (P0(1 "" F))] + g

where

F = the percentage flotation cost incurred in selling new stock, or

(current stock price "" funds going to company) / current stock price

D1= Dividend in next year -

P0= Current stock price -

g = Dividend growth rate

Here, D1= D0* (1 + g) = $3.00 * ( 1 + 0.06) = $3.18. F is given. ke= [ 3.18 / (40 * (1 "" 0.03))] + 0.06 = 0.1420 or 14.20%.

Step 5: Calculate WACC:

WACC = (wd)(kd) + (wps)(kps) + (ws)(ks)+ (we)(ke)

where wd, wps, wsandweare the weights used for debt, preferred stock, retained earnings, and common equity.

Here, WACC = (0.30 * 4.22%) + (0.20 * 8.33%) + (0.15 * 10.5%) + (0.35 * 14.2%) =9.49%.

Note:Your calculation may differ slightly, depending on whether you carry all calculations in your calculator, or round to two decimals and then calculate.