Financial Management For Com ✓ Solved

Financial Managementford Com

Financial Managementford Com

Calculate Ford's weighted average cost of capital (WACC) based on the following data: the market value of Ford's equity is $7 billion, preferred stock is $3 billion, and debt is $10 billion. Ford has a beta of 1.8, the market risk premium is 7%, and the risk-free rate is 4%. The preferred stock pays a $3.5 dividend annually and trades at $27 per share. Ford's debt has a yield to maturity (YTM) of 9.5%. The company's tax rate is 30%. Determine the WACC considering the given inputs and the appropriate cost calculations for equity, preferred stock, and debt.

Sample Paper For Above instruction

Introduction

The Weighted Average Cost of Capital (WACC) is a critical financial metric used to evaluate a company's cost of capital, blending the costs of equity, preferred stock, and debt. It serves as a crucial component in investment decision-making, valuation, and corporate financing strategy. For Ford, a comprehensive calculation of WACC incorporates various data points, including market values, risk premiums, dividend payouts, and debt yields. This paper aims to systematically determine Ford's WACC based on provided financial data, incorporating standard formulas and industry best practices.

Calculating Cost of Equity

The cost of equity (Ke) can be estimated using the Capital Asset Pricing Model (CAPM), which considers the risk-free rate, beta, and market risk premium. The formula is:

Ke = Rf + β × (Market Risk Premium)

Where:

  • Rf = Risk-free rate = 4%
  • β = Beta = 1.8
  • Market Risk Premium = 7%

Applying these values:

Ke = 4% + 1.8 × 7% = 4% + 12.6% = 16.6%

Thus, the cost of equity for Ford is approximately 16.6%.

Calculating Cost of Preferred Stock

The cost of preferred stock (Kp) represents the return required by preferred shareholders. It is calculated as:

Kp = Dividend / Price per Share

Given:

  • Dividend per share = $3.5
  • Price per share = $27

Calculating:

Kp = $3.5 / $27 ≈ 0.1296 or 12.96%

Therefore, Ford's preferred stock has an approximate cost of 12.96%.

Calculating Cost of Debt

The cost of debt (Kd) is based on the yield to maturity (YTM) of Ford's debt, adjusted for taxes because interest expense is tax-deductible. The after-tax cost of debt is calculated as:

Kd( after-tax ) = YTM × (1 - Tax Rate)

Given:

  • YTM = 9.5%
  • Tax Rate = 30%

Applying the values:

Kd( after-tax ) = 9.5% × (1 - 0.3) = 9.5% × 0.7 = 6.65%

Ford's after-tax cost of debt is approximately 6.65%.

Calculating Market Values and Weights

The total market value of Ford's capitalization is the sum of equity, preferred stock, and debt:

  • Equity (E) = $7 billion
  • Preferred (P) = $3 billion
  • Debt (D) = $10 billion

Total capitalization:

Total = 7 + 3 + 10 = $20 billion

The weights are then:

  • Weight of Equity (We): E / Total = 7 / 20 = 0.35 or 35%
  • Weight of Preferred Stock (Wp): P / Total = 3 / 20 = 0.15 or 15%
  • Weight of Debt (Wd): D / Total = 10 / 20 = 0.5 or 50%

Calculating WACC

The general formula for WACC is:

WACC = (We × Ke) + (Wp × Kp) + (Wd × Kd after-tax)

Substituting the computed values:

WACC = (0.35 × 16.6%) + (0.15 × 12.96%) + (0.50 × 6.65%)

Calculating each component:

  • Equity component: 0.35 × 16.6% = 5.81%
  • Preferred stock component: 0.15 × 12.96% = 1.94%
  • Debt component: 0.50 × 6.65% = 3.33%

Adding these together:

WACC = 5.81% + 1.94% + 3.33% = 10.98%

Therefore, Ford's weighted average cost of capital is approximately 11.0%.

Conclusion

By integrating the costs of equity, preferred stock, and debt, and factoring in their respective proportions within Ford's capital structure, the WACC provides a vital indicator of the company's cost of raising funds. The calculated WACC of approximately 11.0% offers insights into Ford's investment decision-making and valuation processes, reflecting the company's risk profile and capital structure management strategies.

References

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