Weighted average cost of capital (WACC)

Business & Finance
Tutor: None Selected Time limit: 1 Day

Given the following information on Big Brothers, Inc. capital structure, compute the company’s weighted average cost of capital (WACC). The company’s marginal tax rate is 40%.

Round the answer to two decimal places in percentage form. 

Type of CapitalPercent of Capital StructureBefore-Tax Component Cost
Bonds41%13.46%
Preferred Stock14%15.89%
Common StockPlease calculate it17.73%
Sep 23rd, 2015

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Answer:

Formula for calculating WACC:

WACC = (Weight of Equity X Cost of Equity) + (Weight of Preferred Stock X 

 Cost of Preferred Stock) + [Weight of debt X Cost of Debt (1 - Tax)]

Here we substitute the values as per the question :-

Weight of Equity = 45% = 0.45

Cost of Equity = 17.73% = 0.1773

Weight of Preferred Stock = 14% = 0.14

Cost of Preferred Stock = 15.89% = 0.098

Weight of debt = 41% = 0.41

Cost of Debt = 13.46% = 0.1346

1 - Tax = 1 - 40 = 60% = 0.60

WACC = (Weight of Equity X Cost of Equity) + (Weight of Preferred Stock X 

 Cost of Preferred Stock) + [Weight of debt X Cost of Debt (1 - Tax)]

WACC = (0.45 X 0.1773) + (0.14 X 0.1589) + (0.41 X 0.1346 X 0.60)

 = 0.08 + 0.02 + 0.03

 = 0.13

 = 13 %

Therefore Big Brothers, Inc.  WACC is = 13 %.


Please let me know if you need any clarification. I'm always happy to answer your questions.
Sep 23rd, 2015

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