A firm wishes to calculate the weighted average cost of capital according to the

Question

A firm wishes to calculate the weighted average cost of capital according to the following weights: 40% long term debt, 10% preferred stock, and 50% common equity (retained earnings and or common stock). The firm's tax rate is 40%.

Pertinent information is as follows:

Cost of debt: 9.4%

Cost of preferred stock: 12.7%

Cost of retained earnings: 14.79%

Breakpoint (associated with exhaustion of retained earnings): $14,000,000

Retained earnigns: $7,000,000

What is the weighted average cost of capital between zero and the break point? Please be detailed. Thanks!

Explanation / Answer

Cost of debt after tax = 9.40*(1-0.40) = 5.64%

weighted average cost of capital = Cost of debt after tax*Weight of Debt + Cost of preferred stock*weight of Preferred Stock + Cost of retained earnings*weight of Retained earning

weighted average cost of capital = 5.64*40% + 12.7*10% + 14.79*50%

weighted average cost of capital = 10.92%

Answer:

weighted average cost of capital =10.92%

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