THE WEIGHTED AVERAGE COST OF CAPITAL

The weighted average cost of capital (WACC) is calculated using the firm's target capital structure
together with its after-tax cost of debt, cost of preferred stock, and cost of common equity.

PROBLEM
A firm's target capital structure consists of 30 percent debt, 10 percent preferred stock, and 60
percent common equity. Using the relevant costs calculated previously, what is the firm's
weighted average cost of capital?
W R W*R
wd = 30% rd = 6.6 1.98
wp = 10% rp = 10.25641 1.025641
ws = 60% rs = 14.58667 8.752
WAAC 11.75764
WACC Problems

Suppose a company uses only debt and internal equity to Finance its capital budget and uses CAPM to compute its
cost of equity. The capital structure is 75% debt and 25% internal equity. Before tax cost of debt is 12.5 % and tax
rate is 20%. Cost f equity is 18%. Calculate WACC.

A company with a tax rate of 30% has the following capital s

Weight Instrument Pre-tax cost of capital
40% Bonds 6%
50% Ordinary shares 12%
10% Preference shares 8%
What is the company’s weighted average cost of capital?
APM to compute its
bt is 12.5 % and tax

owing capital structure:

t of capital

of capital?
 Given the long-run gFCF = 6%, and firm discount rate of 10%, use the cah flow model to find the firm’s
value, if FCF for year 1, 2 and 3 are -5, 10 and 20 respectively. If the firm has $40 million in debt and has 10
million shares of stock, what is the firm’s stock value per share?
 EARNINGSSS MULTIPLIER APPROACH

EPS 1.4
Dividend 0.49 EPS1 ( 1  b )
ROE 15% ke   br (g  br)
P0
Require
Return 12% EPS1
DPR 0.35  (b  0)
b 0.65 P0
groth(br) 9.75%
stock
Value 21.777777778

Calculate the growth rate and stock value as the ROE changes