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The Weighted Average Cost of Capital
For a firm with three sources: debt, preferred stock and common stock, the cost of capital is the weighted average cost of all these three source :
(a) A firm borrows money at 6% after taxes and pays 9% for preferred stock and 12% for common stock. The company raises capital in equal proportions i.e. 1/3 debt and 1/3 preferred stock and 1/3 common stock. The tax rate is 30%.
WACC =
(b) A firm borrows money at 6% before taxes and pays 9% for preferred stock and 12% for common stock. The company raises capital in equal proportions i.e. 1/3 debt and 1/3 preferred stock and 1/3 common stock. The tax rate is 30%.
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