Question

7. Solving for the WACC Aa Aa= The WACC is used as the discount rate to evaluate various capital budgeting projects. However, it is important to realize that 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 Turnbull Co. Turnbull Co, has a target capital structure of 58% debt, If its current tax rate is 40%, how much higher will 6% preferred stock, and 36% common equity. It has a Turnbull's weighted average cost of capital (WACC) be if before-tax cost of debt of 8.2%, and its cost of preferred it has to raise additional common equity capital by stock is 9.3% issuing new common stock instead of raising the funds through retained earnings? If Turnbull can raise all of its equity capital from retained O 0.80% eamings, its cost of common equity will be 12.4%. O 0.77% However, if it is necessary to raise new common equity, O 0.58% it will carry a cost of 14.2%. O 0.64%

Answer 1

Turnbull Co

Question 1) difference between WACC of turnbull co if it is raised equity through Issue of common stock instead of retained earnings

Ans: (36%*14.2) - (36% * 12.4%) = Option D) 0.64%

Q2: Computation of WACC of turnbull co. for new investment of 270,000

Type of capital	Proportion of Capital	Cost of Capital (after tax)	Multiplied Value (total = WACC)
Debt	(100000/270000) =0.37037	9.6*(1-.4) = 5.76%	2.1333%
Equity	(140000/270000) = 0.518518	13.5%	7%
Preferred Stock	(30000/270000) = 0.1111	10.7%	1.18889%
		WACC	10.3222

Case of Kuhn Co as per Image attched:

Kuhn Co
Computation of Cost of each type of capital
1. Cost of debt: it is given in question that the new debt will yield same as existing debt yield
	For computing Cost of debt, we can use IRR method
	Year	Cashflow after tax
	0	1555.38
	1	-66
	2	-66
	3	-66
	4	-66
	5	-66
	6	-66
	7	-66
	8	-66
	9	-66
	10	-66
	11	-66
	12	-66
	13	-66
	14	-66
	15	-1066
	Cost of Debt	2.20965%
	Using IRR equation, and it is given in question that bond is redeemable after 15 years.

2. Cost preferance shares:
KP = preferance Dividend / Market Price
	Preferance Dividend	9
	market Price	95.7
	Kp	9.404%
3. Cost Equity
Ke= (D1/ P) + G	Expected Dividend	1.36
	Current price	33.35
	Flotation cost (need to be deducted from price) 3%	3%
	Price after Floation	32.3495
	growth rate	8.70%
	Cot of Equity	12.904%
WACC computation
type of Capital	Proporation	Cot of Capital	WACC
equity	63%	12.904%	8.130%
debt	35%	2.20965%	0.773%
preferance	2%	9.404%	0.188%
		WACC	9.091%