The WACC is a weighted average of the costs of debt, preferred stock, and common equity....
The WACC is a weighted average of the costs of debt, preferred stock, and common equity. Would the WACC be different if the equity for the coming year came solely in the form of retained earnings versus equity from the sale of new common stock? Would the calculated WACC depend in any way on the size of the capital budget? How might dividend policy affect the WACC?
Homework Answers
Yes. Cost of retained earnings is typically lower than cost of new equity. Hence, WACC will be higher if equity came from new equity.
Yes. If the capital budget can be managed through retained earnings, it should be lower than if the company has to raise new equity to meet capital budget.
Change in dividend policy will change in cost of equity, which in turn will change in WACC.
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The WACC is a weighted average of the costs of debt, preferred
stock, and common equity....
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The firm's target capital structure is the mix of debt, preferred stock, and common equity the firm plans to raise funds for its future projects. The target proportions of debt, preferred stock, and common equity, along with the cost of these components, are used to calculate the firm's weighted average cost of capital (WACC). If the firm will not have to issue new common stock, then the cost of retained earnings is used in the firm's WACC calculation. However, if...
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