WACC with Three Sources

Calculate WACC when a firm uses debt, common equity, and preferred stock.

Problem Scenario

A firm has 50% common equity (Re = 13%), 35% debt (Rd = 7%), and 15% preferred stock (Rp = 9%). Tax rate is 30%.

Given Data

Equity weight50%

Cost of equity13%

Debt weight35%

Cost of debt7%

Preferred weight15%

Cost of preferred9%

Tax rate30%

Requirements

Calculate WACC
Identify which component contributes most

Solution

Step 1:

Equity: 0.50 × 0.13 = 0.065.

Step 2:

Debt (after-tax): 0.35 × 0.07 × (1-0.30) = 0.35 × 0.049 = 0.01715.

Step 3:

Preferred: 0.15 × 0.09 = 0.0135.

Step 4:

WACC = 0.065 + 0.01715 + 0.0135 = 0.09565.

Final Answer

WACC ≈ 9.57%. Equity is the largest contributor.

Key Takeaways

✓Only debt gets the tax shield
✓Preferred stock is not tax-deductible like debt

Common Errors to Avoid

✗Tax-adjusting preferred stock (only debt is tax-deductible)
✗Using book weights instead of market weights

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FAQs

Common questions about this problem type

Preferred dividends are paid from after-tax earnings, unlike interest which is deducted before taxes.

Use the standard two-source WACC: (E/V) x Re + (D/V) x Rd x (1-T). The three-source version simply adds a preferred stock term with no tax adjustment.