The target capital structure for QM Industries is 42% common stock, 12% preferred stock, and 46% debt. IF the cost of common equity for the firm is 18.9%, the cost of preferred stock is 9.2%, the before-tax cost of debt is 8.4%, and the firm's tax rate is 35%, what is QM's weighted average cost of capital?
To find the weighted average cost of capital (WACC) for QM Industries, we need to calculate the weighted cost of each component of the capital structure and then sum them up. Here's how you can do it:
Step 1: Calculate the weight of each component:
- Weight of common stock = 42%
- Weight of preferred stock = 12%
- Weight of debt = 46%
Step 2: Calculate the cost of each component using the given information:
- Cost of common equity = 18.9%
- Cost of preferred stock = 9.2%
- Before-tax cost of debt = 8.4%
Step 3: Adjust the before-tax cost of debt for the tax rate:
- After-tax cost of debt = Before-tax cost of debt * (1 - Tax Rate)
- After-tax cost of debt = 8.4% * (1 - 0.35) = 5.46%
Step 4: Calculate the weighted cost of each component:
- Weighted cost of common equity = Weight of common stock * Cost of common equity
- Weighted cost of preferred stock = Weight of preferred stock * Cost of preferred stock
- Weighted cost of debt = Weight of debt * After-tax cost of debt
Step 5: Sum up the weighted costs of each component to get the WACC:
- WACC = Weighted cost of common equity + Weighted cost of preferred stock + Weighted cost of debt
Now, let's calculate it:
Weighted cost of common equity = 42% * 18.9% = 7.938%
Weighted cost of preferred stock = 12% * 9.2% = 1.104%
Weighted cost of debt = 46% * 5.46% = 2.5156%
WACC = 7.938% + 1.104% + 2.5156% = 11.5576%
So, QM Industries' weighted average cost of capital (WACC) is approximately 11.56%.