Evans Technology has the following capital structure. Debt 40 % Common equity 60 The aftertax cost...

Evans Technology has the following capital structure. Debt 40 % Common equity 60 The aftertax cost of debt is 8.00 percent, and the cost of common equity (in the form of retained earnings) is 15.00 percent.

a. What is the firm’s weighted average cost of capital? (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)

An outside consultant has suggested that because debt is cheaper than equity, the firm should switch to a capital structure that is 50 percent debt and 50 percent equity. Under this new and more debt-oriented arrangement, the aftertax cost of debt is 9.00 percent, and the cost of common equity (in the form of retained earnings) is 17.00 percent.

b. Recalculate the firm's weighted average cost of capital. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)

c. Which plan is optimal in terms of minimizing the weighted average cost of capital? Plan A Plan B

Solutions

Expert Solution

a. What is the firm’s weighted average cost of capital? (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)

WACC = Wd x rd + We x re

WACC = 0.4 x 0.08 + 0.6 x 0.15

WACC = 0.032 + 0.09

WACC = 0.122 or 12.2%

b. Recalculate the firm's weighted average cost of capital. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)

WACC = Wd x rd + We x re

WACC = 0.5 x 0.09 + 0.5 x 0.17

WACC = 0.045 + 0.085

WACC = 0.13 or 13%

c. Which plan is optimal in terms of minimizing the weighted average cost of capital? Plan A Plan B

Plan A is optimal since it has lowest WACC of 12.2% as against plan B of 13%

jeff jeffy answered 1 year ago

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