The taught capital structure for QM Industries is 45% common stock 7% preferred and 48% debt. If the cost of common equity for the firm is 17%, the cost of preferred stock is 10%, the before-tax cost of debt is 8.4% and the firm tax rate is 35%, what is the weighted average cost of capital. QM's Wacc is ( ) % round to three decimal places.
How to work the problem.
To calculate the weighted average cost of capital (WACC) for QM Industries, you need to calculate the individual costs of each component of the capital structure and then weight them by their respective proportions.
1. Calculate the cost of equity (common stock):
Cost of Common Equity = Cost of Equity × Proportion of Common Stock
Cost of Common Equity = 0.17 × 0.45
2. Calculate the cost of preferred stock:
Cost of Preferred Stock = Cost of Preferred Stock × Proportion of Preferred Stock
Cost of Preferred Stock = 0.10 × 0.07
3. Calculate the after-tax cost of debt:
After-Tax Cost of Debt = Before-Tax Cost of Debt × (1 - Tax Rate)
After-Tax Cost of Debt = 0.084 × (1 - 0.35)
4. Calculate the weight of each component:
Weight of Common Stock = Proportion of Common Stock
Weight of Preferred Stock = Proportion of Preferred Stock
Weight of Debt = Proportion of Debt
5. Calculate the weighted average cost of capital (WACC):
WACC = (Weight of Common Stock × Cost of Common Equity) + (Weight of Preferred Stock × Cost of Preferred Stock) + (Weight of Debt × After-Tax Cost of Debt)
Now let's plug in the values and calculate the WACC for QM Industries:
1. Cost of Common Equity = 0.17 × 0.45 = 0.0765
2. Cost of Preferred Stock = 0.10 × 0.07 = 0.007
3. After-Tax Cost of Debt = 0.084 × (1 - 0.35) = 0.0546
4. Weights:
Weight of Common Stock = 0.45
Weight of Preferred Stock = 0.07
Weight of Debt = 0.48
5. WACC = (0.45 × 0.0765) + (0.07 × 0.007) + (0.48 × 0.0546) = 0.045405 + 0.00049 + 0.026208 = 0.071103
The weighted average cost of capital (WACC) for QM Industries is approximately 7.110% (rounded to three decimal places).