This is an unweighted average of the costs of preferred stock and common stock. This is incorrect for two reasons: (1) the average should be a weighted average, weighted according to each component's percentage of the total capital; and (2) the cost of debt is not included in the calculation.
This is an unweighted average of the costs given in the problem. This is incorrect for two reasons: (1) the average should be a weighted average, weighted according to each component's percentage of the total capital; and (2) the cost of debt used is the before-tax cost of debt instead of the after-tax cost of debt.
This answer results from using the before-tax cost of debt instead of the after-tax cost of debt to calculate the weighted average cost of capital.
Kielly had net income available to common shareholders of $184 million last year of which 75% was paid out in dividends. Therefore, 25% (100% ? 75%) of its net income was retained in the company. So 25% of $184 million, or $46 million, will be available from retained earnings. This is exactly the amount that Kielly wants to use from common equity to fund its $100 million expansion, since 46% of the funding is to come from common equity. This tells us that Kielly will not need to issue any new common stock to fund the expansion, because it will be able to get all of the money it needs to get from common equity from its retained earnings. The before-tax cost of debt is given as 11%. The company's marginal tax rate is 40%. Therefore, the after-tax cost of debt is .11 × (1 ? .40), which is .066 or 6.6%. The costs of the other components of the company's total capital to be raised are given in the problem as 12% for preferred stock and 16% for common stock (retained earnings). So the weighted average cost of capital is (.30 × .066) + (.24 × .12) + (.46 × .16) = .1222 or 12.22%.
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Kielly had net income available to common shareholders of $184 million last year of which 75% was paid out in dividends. The company has a marginal tax rate of 40%. Additional data: The before-tax cost of debt is estimated to be 11%. The market yield of preferred stock is estimated to be 12%. The after-tax cost of common stock is estimated to be 16%. What is Kielly's weighted average cost of capital?