Question

9. KC Construction Company has the following amounts of interest-bearing debt and common equity capital: Financing Source Dollar Amount Interest Rate Cost of Capital Short-term loan $200.000 12% Long-term loan $200,000 14% Equity capital $600,000 22% Calculate the weighted average cost of capital (WACC) for the company.

Answer 1

Capital generally refers to the fund that is used by a firm to fund its long term requirements. According to the definition, capital includes equity (and preferred shares) and long term debt.

Short term loans are used to fund short term requirements. We don’t classify short term loans or liabilities under capital.

Hence, you don’t have to include the short term debt while calculating WACC. Only include cost of equity, cost of preferred stock and cost of long term debt while calculating WACC.

So here,

Particulars	Cost	Market value	weights= market value / total	cost * weights
long term loan	14%	$        200,000	=200000/800000= 0.25	0.14*0.25	0.035
Equity	22%	$        600,000	= 600000/800000= 0.75	0.22*0.75	0.165
		$        800,000	1.00		0.20

So WACC= 0.20 or 20%