Kellogg’s CFO is in the process of determining the firm’s WACC and needs to figure out the weights of the various types of capital sources. Accordingly, she starts by collecting information from the balance sheet and the capital markets, and makes up the table shown below: Component Balance Sheet Value Number Outstanding Current Market Price Market Value Debt $150,000,000 150,000 $1,075 Preferred Stock $ 45,000,000 1,500,000 $40 Common Stock $180,000,000 4,500,000 $45.57 Corporate tax rate = 30% is Tc Before tax cost of debt = 7.6% Rd Cost of Equity = 11.36% Re Based upon the above information, calculate the firm’s weighted average cost of capital.
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Kellogg’s CFO is in the process of determining the firm’s WACC and needs to figure out the weights of the various types of capital sources. Accordingly, she starts by collecting information from the
|
Component |
Balance |
Number Outstanding |
Current Market Price |
Market Value |
|
Debt |
$150,000,000 |
150,000 |
$1,075 |
|
|
|
$ 45,000,000 |
1,500,000 |
$40 |
|
|
Common Stock |
$180,000,000 |
4,500,000 |
$45.57 |
|
Corporate tax rate = 30% is Tc
Before tax cost of debt = 7.6% Rd
- Based upon the above information, calculate the firm’s weighted average cost of capital.
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