Explanation

To calculate the Weighted Average Cost of Capital (WACC), we use the formula:

$\text{WACC} = w_d \times r_d \times (1 - t) + w_e \times r_e + w_p \times r_p$

Where:

• $w_d$ = proportion of debt = 40% = 0.40
• $r_d$ = before-tax cost of debt = 8% = 0.08
• $t$ = marginal tax rate = 25% = 0.25
• $w_e$ = proportion of equity = 50% = 0.50
• $r_e$ = cost of equity = 16% = 0.16
• $w_p$ = proportion of preferred shares = 10% = 0.10
• $r_p$ = cost of preferred shares = 10% = 0.10

Step-by-step calculation:

1. After-tax cost of debt: $r_d \times (1 - t) = 0.08 \times (1 - 0.25) = 0.08 \times 0.75 = 0.06$ or 6%

2. Weighted cost of debt: $w_d \times r_d \times (1 - t) = 0.40 \times 0.06 = 0.024$ or 2.4%

3. Weighted cost of equity: $w_e \times r_e = 0.50 \times 0.16 = 0.08$ or 8%

4. Weighted cost of preferred shares: $w_p \times r_p = 0.10 \times 0.10 = 0.01$ or 1%

5. Total WACC: $0.024 + 0.08 + 0.01 = 0.114$ or 11.4%

Verification:

• Debt component: 40% × 6% = 2.4%
• Equity component: 50% × 16% = 8%
• Preferred component: 10% × 10% = 1%
• Total: 2.4% + 8% + 1% = 11.4%

Therefore, the company's WACC is 11.4%, which corresponds to option B.

Why not the other options?

• A. 11.2%: This would result from forgetting to adjust the debt cost for taxes or making a calculation error.
• C. 12.2%: This would result from using the before-tax cost of debt (8%) instead of the after-tax cost (6%), giving: 40%×8% + 50%×16% + 10%×10% = 3.2% + 8% + 1% = 12.2%.