Assume the market value of Apple’s equity, preferred stock, and debt are $6 billion, $2 billion, and $12 billion, respectively. Apple has a beta of 1.7, the market risk premium is 8%, and the risk-free rate of interest is 3%. Apple’s preferred stock pays a dividend of $4 each year and trades at a price of $40 per share. Apple’s debt trades with a yield to maturity of 8.0%.

What is Apple’s weighted average cost of capital if its tax rate is 30%?

A. 9.95%

B.9.34%

C.10.43%

D.11.38%

9.34%

Explanation:

WACC is the average cost of capital of the firm based on the weightage of the debt and weightage of the equity multiplied to their respective costs.

According to WACC formula

WACC = ( Cost of equity x Weightage of equity ) + ( Cost of preferred stock x Weightage of preferred stock ) + ( Cost of debt ( 1- t) x Weightage of debt )

Weightage

Equity = $6 billion / $20 billion = 30%

Preferred Stock = $2 billion / $20 billion = 10%

Debt = $12 billion / $20 = 60%

Total Market Value = $6 billion + $2 billion + $12 billion = $20 billion

Cost of equity

Capital asset pricing model measure the expected return on an asset or investment. it is used to make decision for addition of specific investment in a well diversified portfolio.

Formula for CAPM

Cost of equity = Risk free rate + beta ( market risk premium )

Cost of equity  = 3% + 1.7 (8%) = 16.6%

Cost of Preferred share = (4 /40) x 100 = 10%

Cost of Debt = YTM = 8.0%

Placing values in WACC formula

WACC = ( 16.6% x 30% ) + ( 10% x 10% ) + ( 8% ( 1- 30%) x 60% )

WACC = 4.98% + 1% + 3.36% = 9.34%

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