Question

Quantitative Problem: Barton Industries expects that its target capital structure for raising funds in the future for its capital budget will consist of 40% debt, 5% preferred stock, and 55% common equity. Note that the firm's marginal tax rate is 40%. Assume that the firm's cost of debt, rd, is 7.8%, the firm's cost of preferred stock, rp, is 7.3% and the firm's cost of equity is 11.8% for old equity, rs, and 12.42% for new equity, re. What is the firm's weighted average cost of capital (WACC1) if it uses retained earnings as its source of common equity? Round your answer to 3 decimal places. Do not round intermediate calculations. % What is the firm's weighted average cost of capital (W C2) if it has to issue new common stock? Round your answer to 3 decimal places. Do not round intermediate calculations. %

Answer 1

Ans:- WACC is calculated by weights of equity*cost of equity+weights of preferred stock * cost of preferred stock+weights of debt*cost of debt*(1-tax rate)

(a) WACC1 = 0.55*11.8%+0.05*7.3%+0.40*7.8%*(1-0.40) = 8.727%.

(b) If cost of new equity is 12.42%, then

WACC2 = 0.55*12.42%+0.05*7.3%+0.40*7.8%*(1-0.40) = 9.068%.

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