In: Accounting
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 |
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.