Debreu Beverages has an optimal capital structure that is 70% common equity, 10% preferred stock, and 20% debt. Debreu's pretax cost of equity is 9%. Its pretax cost of preferred equity is 7%, and its pretax cost of debt is also 5%. If the corporate tax rate is 21%, what is the weighted average cost of capital?
A) 8.74%
B) 8%
C) 5.2%
D) 7.79%

Question

Quizplus · Accepted Answer

The weighted average cost of capital (WACC) is calculated as follows: WACC = (E/V * Re) + ((D/V * Rd) * (1-Tc)) + (P/V * Rp) where E = market value of the firm's equity, D = market value of the firm's debt, P = market value of the firm's preferred stock, V = E + D + P (total market value of the firm), Re = cost of equity, Rd = cost of debt, Rp = cost of preferred equity, and Tc = corporate tax rate. Plugging in the given values: WACC = (0.7 * 0.09) + (0.2 * 0.05 * (1-0.21)) + (0.1 * 0.07) = 0.063 + 0.0079 + 0.007 = 0.0779 or 7.79%.

Debreu Beverages Has an Optimal Capital Structure That Is 70