I need to calculate the WACC with the following information:
Cost of debt = 7%
Cost of preferred stock is 7.5%
Cost of common stock via the CAPM = 6.8%
Cost of common stock via the DDM = 7.8%
Cost of common stock via the Earnings Multiplier Approach = 8.4%
I was told that it's not cumulative, but I'm not sure what this means. Since there's three different values for the cost of common stock, does this mean I can't solve for the WACC?
Cumulative means that you add the costs together. In this case, since you have three different values for the cost of common stock, you cannot simply add them together to get the WACC. However, you can still calculate the WACC by taking a weighted average of the different costs of capital.
To calculate the WACC, you need to know the weights (proportions) of each component in the company's capital structure. This typically includes debt, preferred stock, and common stock.
Once you have the weights, you can calculate the weighted average cost of capital (WACC) using the formula:
WACC = (Weight of Debt * Cost of Debt)
+ (Weight of Preferred Stock * Cost of Preferred Stock)
+ (Weight of Common Stock * Cost of Common Stock)
Here's an example calculation using the information you provided:
Assuming the weights of each component in the capital structure are as follows:
- Debt: 40%
- Preferred Stock: 10%
- Common Stock: 50%
WACC = (0.40 * 7%) + (0.10 * 7.5%) + (0.50 * 6.8%) = 2.8% + 0.75% + 3.4% = 6.95%
Therefore, the WACC in this case would be 6.95%.
Please note that the weightings used in the formula are specific to each company's capital structure and should be based on market values or target capital structure.
To calculate the Weighted Average Cost of Capital (WACC), you need to consider the weightings of each component of capital (debt, preferred stock, and common stock) in the company's capital structure.
The WACC formula is given by the following equation:
WACC = (Wd * Rd) + (Wps * Rps) + (Wcs * Rcs)
- Wd represents the weight of debt in the capital structure
- Rd represents the cost of debt
- Wps represents the weight of preferred stock in the capital structure
- Rps represents the cost of preferred stock
- Wcs represents the weight of common stock in the capital structure
- Rcs represents the cost of common stock
The cost of common stock you provided is given through three different approaches (CAPM, DDM, Earnings Multiplier Approach). However, you need to determine the weights of these three approaches in the company's capital structure to incorporate them into the WACC calculation.
The statement that it is not cumulative likely means that the weights of each common stock approach are mutually exclusive, meaning only one should be used in the WACC calculation. You should determine which approach is most suitable for your specific company and use only that approach.
For example, if you decide to use the cost of common stock via the CAPM approach, you would exclude the costs of common stock via the DDM and Earnings Multiplier Approach from the WACC calculation.
In conclusion, you can still calculate the WACC using the provided information, but you need to determine the weights of each component in the company's capital structure and choose only one approach for the cost of common stock to incorporate into the calculation.