Question

Promo Pak has compiled the following financial data: Source of Capital Book Value Market Value Cost Long-term debt $ 10,000,000 $ 12,000,000 6.0% Preferred stock 1,000,000 1,200,000 12.0 Common stock equity 12,000,000 15,000,000 15.0 ------------ ------------ $23,000,000 $28,200,000 a. Calculate the weighted average cost of capital using book value weights. b. Calculate the weighted average cost of capital using market value weights.

Answer 1

		Book value	Market value	Cost of capital
	Long-term debt	10,000,000	12,000,000	6%
	Preferred stock	1,000,000	1,200,000	12%
	Common stock equity	12,000,000	15,000,000	15%
		23,000,000	28,200,000
	a. Calculate the weighted average cost of capital using book value weights
		Book value	Weight	Cost of capital	Weight* cost
	Long-term debt	10,000,000	43.48%	6.00%	2.61%
	Preferred stock	1,000,000	4.35%	12.00%	0.52%
	Common stock equity	12,000,000	52.17%	15.00%	7.83%
		23,000,000			10.96%
	therefore Cost of capital =		10.96%
	b. Calculate the weighted average cost of capital using market value weights.
		Book value	Weight	Cost of capital	Weight* cost
	Long-term debt	12,000,000	42.55%	6.00%	2.55%
	Preferred stock	1,200,000	4.26%	12.00%	0.51%
	Common stock equity	15,000,000	53.19%	15.00%	7.98%
		28,200,000			11.04%
	therefore Cost of capital =		11.04%