Corporate Finance : WACC doubt

[HedgeFudge]

Hey guys ,

Was doing my corporate finance reading on Cost of Capital and had a small speed bump in the reading in the first LOS itself .

Question:

Components of capital Book Value Market Value Component cost

Debt $100 $90 8%

Equity $20 $20 10%

Pref.Stock $100 $300 14%

Can someone kindly calculate the WACC and kindly explain it ?

Regards,

HedgeFudge

[Minerva]

What’s the speed bump? The WACC is a weighted average, so you need to find the weights of the individual components of the capital structure using the market values. Steps:

1. Find the weights of each component of the capital structure. In your example, equity is 4.88% of the capital structure (20/410).

2. Multiply each component’s weight by its cost. Add up the results. Also, you’re missing the tax rate for debt; the cost of debt is reduced by (1-T) due to the tax shield associated with debt payments.

[dwheats]

Do not have a calculator on hand but this is how i would do it:

Using market values:

WACC = (Weight of debt)*(Cost of Debt)*(1-Tax Rate) + (Weight of Common Equity)*(Cost of Common Equity) + (Weight of Preferred Equity)*(Cost of preferred Equity)

= (90/410)*(0.08)(1-Tax Rate) + (20/410)*(0.10) + (300/410)*(0.14)

I assume there is a tax rate, the reason we multiple by (1-Tax Rate) for cost of debt is because there is a tax shield on interest expense because it is deductible from your income. For equity (preferred and common), you pay with after-tax dollars.

[olajideanuoluwa001]

ok, the previous guys that commented failed to do justice to your need.

What you should observed is if you were asked to use the book value or the market value. In the case where no such info was given, you’ll have to calculate WACC based on the market value using the same WACC formula.

WACC = Wd*Kd(1-t) + We*Ke + Wp*Kp

Wd = Weightof debt

Kd(1-t) = After tax cost of dent

We and Wp are both the weight of equity and preferred stock, and so on.

[dwheats]

@olajideanuoluwa001

ok, the previous guys that commented failed to do justice to your need.

What you should observed is if you were asked to use the book value or the market value. In the case where no such info was given, you’ll have to calculate WACC based on the market value using the same WACC formula.

WACC = Wd*Kd(1-t) + We*Ke + Wp*Kp

Wd = Weightof debt

Kd(1-t) = After tax cost of dent

We and Wp are both the weight of equity and preferred stock, and so on.

Lols yours isnt exactly any better. And you use Mkt Val because that is the value of your investment and require a return based on what it is worth today… I guess you failed to do justice to their need as well…