Question

8. Solving for a firm's WACC Aa Aa E A firm's weighted average cost of capital (WACC) is used as the discount rate to evaluate various capital budgeting projects. However, remember the WACC is an appropriate discount rate only for a project of average risk. Analyze the cost of capital situations of the following company cases, and answer the specific questions that finance professionals need to address. Consider the case of Fuzzy Button Clothing Company Fuzzy Button Clothing Company has a target capital structure of 45% debt, 4% preferred stock, and 51% common equity. It has a before-tax cost of debt of 11.1%, and its cost of preferred stock is 12.2%. If its current tax rate is 40%, how much higher will Fuzzy Button's weighted average cost of capital (WACC) be if it has to raise additional common equity capital by issuing new common stock instead of raising the funds through retained earnings? If Fuzzy Button can raise all of its equity capital from retained earnings, its cost of common equity will be 14.7%. However, if it is necessary to raise new common equity, it will carry a cost of 16.8%. O 1.44% 01.07% 1.39% O 1.34%

Answer 1

D84 : X fc =+C84/$C$91 B 81 Issuing new common stocks will increase raise the WACC 82 Market value 83 Cost % Market value weights 84 Common stock 13.20% $ 320,000 0.5614 1.07% =(16.8%-14.7%)*51% WACC (Cost %xWeights) 7.411% $ 230,000 0.4035 2.106% 5.22% =8.7%*(1-40%) 86 Debt (After tax cost) 87 88 89 Preferred stock 9.90% $ 20,000 0.0351 0.347% Total $ 570,000 1.0000 Peaceful Book Binding company WACC | 9.86% Cost % 12.90% =1.36/(33.35*(1-3%))+8.7% Market value Market value | weights $ 51 0.5100 WACC (Cost %*Weights) 6.58% 96 Common stock 97 98 99 Debt (After tax cost) 100 $ 45 0.4500 2.35% 5.22% =RATE(5,100,-1050.76,1000)*(1-40%) 101 102 Preferred stock 4 0.0400 0.35% 8.67% $ =8/92.25 103 104 105 Total $ 100 1.0000 106 Chilly Moose Fruit's WACC 9.28%

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