Question

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

  

Type of Financing	Book Value			Market Value			Cost
Short-term debt	$	15,800,000		$	14,400,000		4.6	%
Long-term debt		48,500,000			40,100,000		7.7
Common stock		12,800,000			111,000,000		13.5
Total	$	77,100,000		$	165,500,000

  

The company is in the 24 percent tax bracket and has a target debt-equity ratio of 70 percent. The target short-term debt/long-term debt ratio is 10 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.)
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.)
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.)

    

d.	Which is the correct WACC to use for project evaluation?

    

• Book weights

• Market weights

• Target weights

Answer 1

a)

after tax cost of debt = cost of debt(1 - tax)

for short term = 4.6(1 - 0.24) = 3.496%

long term debt = 7.7(1 - 0.24) = 5.852%

weights = individual value / total value

WACC =

WACC = 6.64%

b)

WACC = 10.78%

c)

WACC =  [W(STD) x K(STD)x (1 - t)] + [W(LTD) x K(LTD)x (1 - t)] + [W(E) x K(E)]

STD , LTD = short and long term debt

E = equity

W , K = weights and cost

we already calculated after tax cost of debts

so WACC = [(0.1 / 1.1) x (0.7/1.7) x 3.496%] + [(1 / 1.1) x (0.7 / 1.17) x 5.852% + [(1 / 1.7) x 13.5 ]

= 10.26%

d)

Market weights is correct