Question

Bolero, Inc., has compiled the following information on its financing costs:

  

Type of Financing	Book Value			Market Value			Cost
Short-term debt	$	11,200,000		$	12,200,000		5.3	%
Long-term debt		4,200,000			4,200,000		8.4
Common stock		7,200,000			27,200,000		15.0
Total	$	22,600,000		$	43,600,000

  

The company is in the 40 percent tax bracket and has a target debt–equity ratio of 60 percent. The target short-term debt/long-term debt ratio is 15 percent.

  

a.	What is the company’s weighted average cost of capital using book value weights? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

  

Weighted average cost of capital

%

  

b.	What is the company’s weighted average cost of capital using market value weights? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

  

Weighted average cost of capital

%

  

c.	What is the company’s weighted average cost of capital using target capital structure weights? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

  

Weighted average cost of capital

%

  

d.	Which is the correct WACC to use for project evaluation?
	Market weights Book weights Target weights

Answer 1

a.

The weighted average cost of capital using book value weights calculated below:

weighted average cost of capital is 8.96%.

b.

The weighted average cost of capital using market value weights is calculated below:

weighted average cost of capital is 11.65%.

c.

Debt equity ratio is 60%.

The debt-value ratio is calculated below:

Thus, equity-value ratio must be 1 - 0.375 = 0.625.

The short-term debt to long-term debt ratio is 15%.

The ratio of short-term debt to total debt is calculated below:

Thus, long-term debt to total debt ratio must be 1 - 0.1304 = 0.8696.

Short-term debt to value ratio is calculated below:

Long-term debt to value ratio is calculated below:

The weighted average cost of capital is calculated below:

weighted average cost of capital is 11.17%.

d.

target weight