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Calculate the opportunity cost of capital (WACC) for a firm with the following capital structure: 53% in debt, 15% in preferred stock, and the remaining fraction in equity.The firms has a cost of debt of 7.12%, a cost of preferred stock equal to 10.9% and a 13.87% cost of common stock. The firm has a 29% tax rate. You answer should be entered as a %, for example 15.48%

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Shahzaibfaraz

Answer:

The WACC is 8.75%

Explanation:

The WACC or weighted average cost of capital is the cost of a firm's capital structure. The capital structure is made up of debt, preferred stock and common stock.

The formula for WACC is,

WACC = wD * rD * (1 - tax rate)  +  wP * rP  +  wE * rE

Where,

  • w represents the weight of each component in the capital structure or value of each component as a proportion of total assets
  • r represents the cost of each component
  • we take after tax cost of debt. So we multiply cost of debt by (1 - tax rate)

The weight of common equity = 1 - (0.53 + 0.15)   =  0.32 or 32%

The WACC is:

WACC = 0.53 * 0.0712 * (1 - 0.29)  +  0.15 * 0.109  +  0.32 * 0.1387

WACC = 0.0875 or 8.75%

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