Question

copy its cuilcils I u spiedusieel) Target market value weight 27% Source of capital Long-term debt Preferred stock Common stock equity Total 60 100%

After careful​ analysis, Dexter Brothers has determined that its optimal capital structure is composed of the sources and target market value weights shown in the following​ table:

The cost of debt is estimated to be 4.1% the cost of preferred stock is estimated to be 9.5%;the cost of retained earnings is estimated to be13%; and the cost of new common stock is estimated to be 15% All of these are​ after-tax rates. The​ company's debt represents 22%,

the preferred stock represents 8​%,and the common stock equity represents70% of total capital on the basis of the market values of the three components. The company expects to have a significant amount of retained earnings available and does not expect to sell any new common stock.

a. Calculate the weighted average cost of capital on the basis of historical market value

weights. round to two decimal places

b.Calculate the weighted average cost of capital on the basis of target market value. round to two decimal places

weights.

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

Answer 1

al Calculation of weighted Average Cost of Capital TWACC on the basis of historical morkervare weights, Source or Capital Cost of Capital Historical Market value Weights Cost of Capirala Weights 4.1 9.5 22% Long Term Debt Preferred Stock Common Stock Equity 0.90 0.76 8% 13 70% 9-10 10.76% :. WACC under bi storical market value weighis 10.76% o Calculation of WACC on the basis of Market value. Target Source of Cost of Capital Dia Target Market Value Weights Cost of Capital x Weights 4.1 9.5 27% 13% 1.11 1. 24 Long Term Debt Preferred Stock Common Stock Equity - 13 60% 7.80 10.15 % Torget market value Weights WACC under = 10-15%

PAGE DATE As per the answers Calculated in af b above we can see that the WACC under historical Market value weight is higher than the target market value weight This is because there is not much difference in the weight of long term debt & preferred Stock I but there is significance difference in the weight of common stock equiry: