Question

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 45% debt, 4% preferred stock, and 51% common equity. It has a before-tax cost of debt of 11.1%, and its cost of preferred stock is 12.2%.

If Turnbull can raise all of its equity capital from retained earnings, its cost of common equity will be 14.7%. However, if it is necessary to raise new common equity, it will carry a cost of 16.8%.

If its current tax rate is 25%, how much higher will Turnbull’s weighted average cost of capital (WACC) be if it has to raise additional common equity capital by issuing new common stock instead of raising the funds through retained earnings? (Note: Round your intermediate calculations to two decimal places.)

1.44%

1.18%

1.34%

1.07%

Answer 1

Answer :- 1.07%

Explanation:-

+ Weighted average cost of capital weight of equlay x cost of equity (WACC) weight of debt x cost of debt x Cl- Taxe Rate) + wergut of_preferred Stock x cost of preferred Stock weight of equity : 51% or 10.51 weigltt of debt = 45% or 10.45 weight of prefereed Stock = 40% or 0.04 cost of preferred stock = 12.2% os 10.122 equity is raised from retained earning the cost of equity la 14.79% or(0.147 If it is recessary to reuse equity new common i equity cost of equity is 16.8% or 0.168 Tax Rate = 25% or [0.25 Before- Tax cost of debt = 11.1% or 10.111 Calauakon of Wale, if .equity is recsed from detained eamings :- WACC 0.51 x 0.147 + 0,45 x 0.111 x (T-0.25) +0.04 x 0.122 0.07497 + 0.0374625 + 0.00488 11.73125 % c CS Scanned with CamScanner

Palutation of wall, If additional common equity issuing new raised by common Stock WACL : 0.51 v 0.168 + 0.45 0.111x C1-0.25) + 0.04 x 0.122 0.08568 + 0.0374625 + 0.00488 0.1280 225 12.80225°% so, Difference between both LUACO = 12.80225% - 1). 73125%. 1.07104- br 1.077- has to raise new colon So, 1.07% of wall will be higher if Turnbull additional common equity capital by issuing instead of raising the funds through reterined Cannings stock CS Scanned with CamScanner