The market value of Fortescue's ordinary shares, preference shares and debt are $8 billion, $4 billion and $12 billion respectively. Fortescue has a beta of 1.3, the market risk premium is 7% and the risk-free rate of interest is 4%. Fortescue's preference shares pays a dividend of $4 each year and trades at a price of $30 per share. Fortescue's debt trades with a yield to maturity of 8.5%. What is Fortescue's weighted average cost of capital if its tax rate is 30%?

Question

Quizplus · Accepted Answer

The correct answer is A.The weighted average cost of capital (WACC) is calculated as follows:WACC = (E/V) * Re + (D/V) * Rd * (1 - T) + (P/V) * Rpwhere:E = market value of equityV = total market value of the firmRe = cost of equityD = market value of debtRd = cost of debtT = tax rateP = market value of preference sharesRp = cost of preference sharesIn this case, we have:E = $8 billionV = $8 billion + $4 billion + $12 billion = $24 billionRe = 1.3 * 7% + 4% = 13.1%D = $12 billionRd = 8.5%T = 30%P = $4 billionRp = $4 / $30 = 13.33%Therefore, the WACC is:WACC = (8/24) * 13.1% + (12/24) * 8.5% * (1 - 0.3) + (4/24) * 13.33% = 9.56%

The Market Value of Fortescue's Ordinary Shares, Preference Shares and Debt