Question

WACC—Market value weights The market values and after-tax costs of various sources of capital used by Ridge Tool are shown in the following table: a. Calculate the firm's weighted average cost of capital. b. Explain how the firm can use this cost in the investment decision-making process. A Data Table - X Round to two decimal places.) (Click on the icon located on the top-right corner of the data table below in order to copy its contents into a spreadsheet.) Source of capital Long-term debt Preferred stock Common stock equity Market value $900,000 $80,000 $600,000 Individual cost 5.7% 12.4% 16.6% Print Done

Answer 1

a). Total Market Value = Value of LTD + Value of Preferred Stock + Value of Common Equity

= $900,000 + $80,000 + $600,000 = $1,580,000

WACC = [wD * kD] + [wP * kP] + [wE * kE]

= [(900,000/1,580,000) * 5.7%] + [(80,000/1,580,000) * 12.4%] + [(600,000/1,580,000) * 16.6%]

= 3.25% + 0.63% + 6.30% = 10.18%

b). The WACC is the rate of return that the firm must receive on long-term projects to maintain the value of the firm. The cost of capital can be compared to the return for a project to determine whether the project is acceptable.