Question

Quantitative Problem: Barton Industries expects that its target capital structure for raising funds in the future for its capital budget will consist of 40% debt, 5% preferred stock, and 55% common equity. Note that the firm's marginal tax rate is 40%. Assume that the firm's cost of debt, rd, is 8.4%, the firm's cost of preferred stock, rps, is 7.9% and the firm's cost of equity is 12.4% for old equity, rs, and 13.02% for new equity, re. What is the firm's weighted average cost of capital (WACC1) if it uses retained earnings as its source of common equity? Round your answer to 3 decimal places. Do not round intermediate calculations. % What is the firm's weighted average cost of capital (WACC2) if it has to issue new common stock? Round your answer to 3 decimal places. Do not round intermediate calculations. 0%

Answer 1

1-a). WACC = [wD * rD * (1 - t)] + [wPS * rPS] + [wS * rS]

= [0.40 * 8.4% * (1 - 0.40)] + [0.05 * 7.9%] + [0.55 * 12.4%]

= 2.016% + 0.395% + 6.820% = 9.231%

1-b). WACC = [wD * rD * (1 - t)] + [wPS * rPS] + [wE * rE]

= [0.40 * 8.4% * (1 - 0.40)] + [0.05 * 7.9%] + [0.55 * 13.02%]

= 2.016% + 0.395% + 7.161% = 9.572%

9-7). WACC = [wD * rD * (1 - t)] + [wPS * rPS] + [wS * rS]

= [0.30 * 6% * (1 - 0.35)] + [0.05 * 7.4%] + [0.65 * 14%]

= 1.17% + 0.37% + 9.10% = 10.64%