Question

 Barton Industries expects that its target capital structure for raising funds in the future for its capital budget will consist of 40% debt, 5% preferred stock, and 55% common equity.

Note that the firm's marginal tax rate is 40%.

Assume that the firm's cost of debt, ld, is 6.8%, the firm's cost of preferred stock, Tp, is 6.3% and the firm's cost of equity is 10.8% for old equity, rs, and 11.25% for new equity, re.

a)What is the firm's weighted average cost of capital (WACC) if it uses retained earnings as its source of common equity? Round your answer to 3 decimal places. Do not round intermediate calculations.

b)What is the firm's weighted average cost of capital (WACC) if it has to issue new common stock? Round your answer to 3 decimal places. Do not round intermediate calculations.

Answer 1

weighted average cost of capital (WACC) if it uses retained earnings as its source of common equity

cost of debt, ld, is 6.8%

cost of preferred stock, Tp, is 6.3%

 cost of equity is 10.8% 

WACC1 = wd x rd x (1 - tax) + wp x rp + we x re

= 40% x 6.8% x (1 - 40%) + 5% x 6.3% + 55% x 10.8%

= 7.887%

weighted average cost of capital (WACC) if it has to issue new common stock

cost of debt, ld, is 6.8%

cost of preferred stock, Tp, is 6.3%

 cost of equity is 11.25%

WACC2 = 40% x 6.8% x (1 - 40%) + 5% x 6.3% + 55% x 11.25%

= 8.1345%

WACC1-7.887% ,WACC2 -8.1345%