The target capital structure for QM Industries is 39% common stock 6% is preferred stock, and 55% debt. If the costs of common equity for the firm is 18.2%, and the cost of preferred stock is 9.4%, the before tax cost of debt is 7.5%, and the firms tax rate is 35% what is QM’s weighted average cost of capital?
To calculate the weighted average cost of capital (WACC) for QM Industries, we need to determine the cost of each component of capital and their respective weights in the overall capital structure.
Given:
- Target capital structure: 39% common stock, 6% preferred stock, and 55% debt
- Cost of common equity (rs): 18.2%
- Cost of preferred stock (rp): 9.4%
- Before-tax cost of debt (rd): 7.5%
- Tax rate (T): 35%
Step 1: Calculate the after-tax cost of debt (rda):
To calculate the after-tax cost of debt, we need to apply the tax rate to the before-tax cost of debt.
rda = rd * (1 - T)
rda = 7.5% * (1 - 35%)
rda = 7.5% * (0.65)
rda = 4.875%
Step 2: Calculate the weights of each component of capital:
We have the target capital structure percentages for each component, which represent their respective weights.
Weight of common stock (wce) = 39%
Weight of preferred stock (wpe) = 6%
Weight of debt (wd) = 55%
Step 3: Calculate the WACC:
WACC is the weighted average of the costs of each component using their respective weights.
WACC = (wce * rs) + (wpe * rp) + (wd * rda)
WACC = (0.39 * 18.2%) + (0.06 * 9.4%) + (0.55 * 4.875%)
WACC = 7.098% + 0.564% + 2.68125%
WACC = 10.34325%
Therefore, QM Industries' weighted average cost of capital (WACC) is 10.34325%.