Question

Ford Motor Company is discussing new ways to recapitalize the firm and raise additional capital. Its current capital structure has a 20% weight in equity, 10% in preferred stock, and 70% in debt. The cost of equity capital is 14%, the cost of preferred stock is 10%, and the pretax cost of debt is 9%. What is the weighted average cost of capital for Ford if its marginal tax rate is 30%?

Answer 1

Answer: 8.21%

Explanation:

The Weighted Average Cost of Capital(WACC) simply put, is the rate at which a company pays those who have invested in it and financed it be it debt holders or equity holders.

The rates in question are averaged according to the proportion by which the company uses the said capital. This results in the following formula,

WACC= [(Wd*Rd) * (1-Tax) + (We * Re) +(Wp * Rp )]

Where,

Wd is the Weight of debt

We is the weight of common Equity

Wp is the weight of preferred Equity

Rd is the Pre-tax cost of debt

Re is the cost of common Equity

Rp is the cost of Preferred equity.

Note: Sometimes you will be given the After - tax cost of debt. In which case you will not need to include the tax adjustment of (1 - tax).

Calculating,

= [( 70% * 9%) * ( 1 - 30%) + (20% * 14%) + (10% * 10%) ]

= 0.0441 + 0.028 + 0.01

= 0.0821

= 8.21%