Question

(Weighted-average cost of capital—calculation) A company has the following capital costs and target capital structure:

Cost Proportion

Bonds Payable 8.25% 50%

Preferred Stock 11.00% 10%

Common Stock 13.5% 40%

Calculate the company’s weighted-average cost of capital under each of the following scenarios:

a. It is calculated correctly.

b. The financial manager accidently omits the bonds payable from the calculation.

c. The financial manager accidently treats the preferred stock as if it were the same as bonds payable.

d. The financial manager accidently weighs each financing source equally.

Answer 1

Scenario wise:

a. WACC = 10.63%

Type	Weights	Cost	WACC
Equity	0.4	13.50%	5.40%
Preference stock	0.1	11%	1.10%
Debt	0.5	8.25%	4.13%
Total	1		10.63%

b. WACC = 6.5%

Type	Weights	Cost	WACC
Equity	0.4	13.50%	5.40%
Preference stock	0.1	11%	1.10%
Total	0.5		6.50%

c. WACC = 10.35%

Type	Weights	Cost	WACC
Equity	0.4	13.50%	5.40%
Debt	0.6	8.25%	4.95%
Total	1		10.35%

d. WACC = 10.92%

Type	Weights	Cost	WACC
Equity	0.333333333	13.50%	4.50%
Preference stock	0.333333333	11%	3.67%
Debt	0.333333333	8.25%	2.75%
Total	1		10.92%