A firm uses $30 million of debt, $10 million of preferred stock, and $60 million of common equity to finance its assets.If the before-tax cost of debt is 8 percent, the cost of preferred stock is 10 percent, and the cost of common equity is 15 percent, calculate the weighted average cost of capital for the firm assuming a tax rate of 35 percent.

Question

Quizplus · Accepted Answer

First, we need to calculate the proportions of each source of financing:

Debt: $30 million / $100 million = 0.3 or 30%
Preferred stock: $10 million / $100 million = 0.1 or 10%
Common equity: $60 million / $100 million = 0.6 or 60%

Next, we calculate the after-tax cost of debt:

After-tax cost of debt = 8% x (1 - 0.35) = 5.2%

Then, we calculate the weighted average cost of capital (WACC):

WACC = (0.3 x 5.2%) + (0.1 x 10%) + (0.6 x 15%) = 1.56% + 1% + 9% = 11.56%

Therefore, the answer is B) 11.56%.

A Firm Uses $30 Million of Debt, $10 Million of Preferred