 # WACC

In calculating the weighted average cost of capital (WACC), which of the following statements is least correct? A) The cost of preferred equity capital is the preferred dividend divided by the price of preferred shares. B) The cost of debt is equal to one minus the marginal tax rate multiplied by the coupon rate on outstanding debt. C) The cost of common equity is equal to the rate of return stockholders require on the firm’s common stock. D) Different methods for estimating the cost of common equity might produce different results.

B

B - YTM

B) is not the coupon rate, but the YTM or interest rate on debt.

B?

You all are right and I agree. But, D. Different methods for estimating the cost of common equity might produce different results. Could someone point if different methods can produce different results?

You all are right and I agree. But, D. Different methods for estimating the cost of common equity might produce different results. Could someone explain if different methods can produce different results?

1. CAPM ke = rfr+beta(E(M)-rfr) 2) Gordon growth model 3) risk premiums approach

there are two questions in schweser that play off that concept. i think they were either in book 6 3am or the cfai q’s in book 7

definetly B

B – they trick you with the Coupon. The REAL cost of debt is ( 1 - T)(interest rate). It is after TAX – ALWAYS – b/c debt conveys a tax advantage to companies since interest exp is TAX DEDUCTIBLE. Hence a Ke is always > Kd. WACC comes in lower than CAPM/Ke precisely b/c of this tax shield.