BEC 3 Weighted Average Cost of Capital and Optimal

Question 1

Define Weighted Average Cost of Capital (WACC)

Answer 1

The WACC is the average cost of debt and equity financing associated with the firm’s existing assets and operations

Question 2

What is the after-tax cost of debt formula (kdx)

Answer 2

kdx = Pretax Cost of Debt x (1 - Tax Rate)

Question 3

What is the cost of preferred stock formula?

Answer 3

kdx = DPS / NPS

DPS = Preferred stock cash dividends

NPS = Net Proceeds of preferred stock

Question 4

What is the cost of retained earnings (Kre) using discount cash flow (DCF)?

Answer 4

KRE = (D1 / P0) = g

D1 = Dividend per share expected at the end of one year

P0 = Current market value of price of outstanding common stock

g = constant growth rate of dividends

Question 5

What is the cost of retained earnings (kre) under bond yield plus risk premium (BYRP)?

Answer 5

kre - kdt + PMR

kdt = Pretax cost of debt

PMR = Market risk premium