Question

4. Byrd Products, Inc. wants to determine the minimum cost of capital point for the company. Assume it is considering the following financial plans Cost (aftertax) Weights Plan A Debt Preferred stock Common equity Plan B Debt Preferred stock Common equity Plan C Debt Preferred stock Common equity Plan D Debt Preferred stock Common equity 5.0% 7.0 12.0 20% 10 70 5.5% 8.0 14.0 30% 10 60 6.0% 9.0 15.0 40% 10 50 9.0% 11.0 17.0 50% 10 40 a.Which of the four plans has the lowest weighted average cost of capital? (Round to two places to the right of decimal point.) b.Briefly discuss the results from Plan C and Plan D, and why one is better than the other

Answer 1

WACC = weight in preferred stock*Cost of preferred stock + weight in common stock*Cost of common stock + weight in debt*Cost of debt

Plan A = 20%*5% + 10%*7% + 70%*12% = 10.10%

Plan B = 30%*5.5% + 10%*8% + 60%*14% = 10.85%

Plan C = 40%*6% + 10%*9% + 50%*15% = 10.80%

Plan D = 50%*9% + 10%*11% + 40%*17% = 12.40%

Plan C is better than Plan D as it has lower WACC moreover it has a higher proportion of debt thus reducing the insolvency risk and protect the assets in case of bankruptcy