Question

on its books the amounts and specifie (after-tax) costs shown in the following 3, Ridge Tool has on its books the amounts and speeine table for each souree of capital source of capital -1--Bookvalue $800,000 50,000 Long-term debe Preferred stock Common stock equity580,000 1) Calculate the firm's weighted average cost of capital (WACC) using book value weights. (& points) Weight for Long-term debt- Weight for Preferred stock- Weight for Common stock- WACC- 2) Explain how the firm can use this cost in the investment decision-making process. (2 points)

Answer 1

Ans 1_
	Source of capital	Book value	Weight	Cost	Weight*cost
	Debt	800,000	55.94%	5.20%	2.91%
	preferred stock	50,000	3.50%	11%	0.38%
	Common equity	580,000	40.56%	15%	6.08%
		1,430,000			9.38%
	Therefore answer
	Weight for long term debt			55.94%
	Weight for preferred stock			3.50%
	Weight for common stock			40.56%
	WACC=			9.38%
Ans 2_
	If use WACC for investment decision. Firm will discount the cash flow and bring every thing back to present value
	Firm will than see if the present value of cash flow >=present value of cash outflow and will compute net present value
	If net present value if greater than equal to zero project will be accepted.