When preferred stock financing is also used by the firm; the after-tax weighted average cost of capital (WACC) is calculated as follows,
A) WACC = rD (D/V) + rP (P/V) + rE (E/V); (where V = D + P + E)
B) WACC = rD (1 - TC)(D/V) + rP (P/V) + rE (E/V); (where V = D + P + E)
C) WACC = rD (D/V) + (1 - TC)[rP (P/V) + rE (E/V)]; (where V = D + P + E)
D) None of the above

Question

Quizplus · Accepted Answer

Option B takes into account the tax shield on debt (1-TC) and correctly weights the cost of debt, preferred stock, and equity by their respective proportions in the capital structure.

When Preferred Stock Financing Is Also Used by the Firm;