Question

TOIVUL Score: 0 of 1 pt P9-14 (similar to) 9 of 11 (5 complete) HW Score: 418 Eu WACC-Book weights and market weights Webster Company has compiled the information shown in the following table BB a. Calculate the weighted average cost of capital using book value weights. b. Calculate the weighted average cost of capital using market value weights C. Compare the answers obtained in parts a and b. Explain the differences a. The firm's weighted average cost of capital using book value weights is % (Round to two decimal places.) Enter your answer in the answer box and then click Check Answer parts Clear All remaining This course (FINA 3313 Spring 2020-Thompson) is based on Zutter/Smart: Principles of Managerial Finance Brief Be C at2 Pearson Educationalac. All Rights Resad

Answer 1

a). Calculating the Weighted Average Cost of Capital (WACC) using the book value of weight:

WACC= (Weight of Debt)(Cost of Debt)+ (Weight of Preferred Stock)(Cost of Preferred Stock) (Weight of Equity)(Cost of Equity)

WACC = (4,000,000/5,100,000)(9%) + (40,000/5,100,000)(12%) + (1060,000/5,100,00)(14%)

WACC = 7.06% + 0.09% + 2.91%

WACC = 10.06%

b). Calculating the Weighted Average Cost of Capital (WACC) using the Market value of weight:

WACC= (Weight of Debt)(Cost of Debt)+ (Weight of Preferred Stock)(Cost of Preferred Stock) (Weight of Equity)(Cost of Equity)

WACC = (3,920,000/8,135,000)(9%) + (60,000/8,135,000)(12%) + (4,155,000/8,135,00)(14%)

WACC = 4.34% + 0.09% + 7.15%

WACC = 11.58%

c). WACC obtained using Book Value weight is 10.06%

WACC obtained using Market Value weight is 11.58%

Difference in WACC in Book Value weight and Market value Weight is -1.52% (10.06%-11.58%)

The difference in WACC arises because in Book value weights value of balance sheet is taken while in market value, market value weights are taken. Market Value WACC are considered more appropriate than Book value, Because market value based return is what investors demand rather than book value.