Webster Company Ltd has compiled the following information.

Source of capital	Book value	Market Value	After tax Cost
Long-term debt	$ 4,000,000	$3,840,000	6.0%
Preference share capital	40,000	60,000	13%
Ordinary share equity	1,060,000	3,000,000	17%
Totals	$5,100,000	6,900,000

Calculate the WACC (to the nearest two decimal places) using book value weights.

Calculate the WACC (to the nearest two decimal places) using market value weights.

Compare the answers obtained in parts a and b. Explain the differences.

Solutions

Expert Solution

Solution to part (a)

Calculation of WACC using book value weights

Book value weights:

Long term debt = (4,000,000/5,100,000) = 0.7843

Preference share capital= (40,000/5,100,000)=0.007843

Equity = = $1,060,000 / $5,100,000 = 0.2078

WACC= (0.7843 x 0.06) + (0.2078 x 0.17) + (0.007843 x 0.13) =8.34%

Solution to part (b)

Calculation of WACC using market value weights.

Market value weights:

Long Term Debt = $3,840,000 / $6,900,000 = 0.5565

Equity= $3,000,000 / $6,900,000 = 0.4347

Prefernce share capital = $60,000 / $6,900,000 = 0.008696

WACC= (0.5565 x 0.06) + (0.4347 x 0.17) + (0.008696 x 0.13) = 10.84%

Solution to part (c)

The differences are due to the increase in the market value of preference share capital and ordinary share equity. When there is an increase in proportion of equity ( from 0.2087 to 0.4347) the WACC will also increase.

ekkarill92 answered 1 year ago

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