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Ford Company Capital Budgeting Project Mini-case

The market value of Fords' equity, preferred stock and debt are $7 billion, $3 billion, and $10 billion, respectively. Ford has a beta of 1.8, the market risk premium is 7%, and the risk-free rate of interest is 4%. Ford's preferred stock pays a dividend of $3.5 each year and trades at a price of $27 per share. Ford's debt trades with a yield to maturity of 9.5%. What is Ford's weighted average cost of capital if its tax rate is 30%?

Ford Company

Market Capitalization Weight

Equity (E)
Preferred (P)
Debt (D)

Total

Ford Company

Weight Cost After-tax
Marginal Weight

Equity (E) X =
Preferred (P) X =
Debt (D) X =

Total X =

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Solution Preview

The market value of Fords' equity, preferred stock and debt are $7 billion, $3 billion, and $10 billion, respectively. Ford has a beta of 1.8, the market risk premium is 7%, and the risk-free rate of interest is 4%. Ford's preferred stock pays a dividend of $3.5 each year and trades at a price of $27 per share. Ford's debt trades with a yield to maturity of 9.5%. What is Ford's weighted average cost of capital if its tax rate is 30%?
Ford Company
Market Capitalization Weight
Equity (E) $7,000,000,000 35%
Preferred (P) 3,000,000,000 15%
Debt (D) 10,000,000,000 50%
Total $20,000,000,000 100%

Cost of Equity (Common Shares) using CAPM
Cost of Equity = Risk Free Rate + Beta × Market Risk ...

Solution Summary

This solution shows how to calculate the weighted average cost of capital (WACC). The solution shows a step by step approach to calculating cost of debt, cost of preferred stock and the cost of common stock using CAPM. Lastly, the solution highlights where they may be risks in the calculation (how the calculation may change over time), how the weighted average cost of capital should be applied when making cost of capital project decisions, and some scenarios that may change the weighted average cost of capital at some future point.

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