Question

Kennedy Limited, a key competitor of Taylor Company in the computer technology field, has a capital structure consisting of 40% debt, 15% preferred stock, and 45% common equity. Concerned that its cost of capital may put it at a competitive disadvantage vis-a-vis the Taylor Company, a Kennedy analyst has been tasked with computing and comparing the weighted costs of capital of both companies. As the Kennedy analyst, and through your dogged research, you've collected the following capital structure and component cost data for both companies. (Remember, you don't have access to confidential financial information for Taylor Company, so you've had to rely on balance sheet data collected from their published financial statements.) Complete the following table by computing each company's weighted cost of capital (rounded to four decimal places) and answer the related question that follows: Financial Data Kennedy Limited Data Taylor Company Data 40% 7.50% 35% 5.75% Debt Weight (wa) Cost (ks) Preferred stock Weight (wp) Cost (ko) Common equity Weight (we) Cost (ke) Tax rate (T) 15% 9.00% 5% 7.25% 45% 11.75% 40% 60% 9.50% 35% Weighted cost of capital (ka) If a firm's weighted cost of capital represents the overall or summary indicator of the market's perception of a firm's riskiness (across its different sources of financing), then which company currently appears to exhibit the greater risk? Kennedy Limited Taylor Company

Answer 1

WACC = sum of weights*after tax costs

Kennedy Ltd

WACC = 40%*7.5%*(1-40%)+15%*9%+45%*11.75%

=8.4375%

Taylor Ltd

WACC = 35%*5.75%*(1-35%)+5%*7.25%+60%*9.5%

=7.3706%

Kemnnedy Ltd has the greater risk since its WACC is higher.