Question

WACC-Book weights and market weights Webster Company has compiled the information shown in the following table: a. Calculate the weighted average cost of capital using book value weights. b. Calculate the weighted average cost of capital using market value weights. c. Compare the answers obtained in parts a and b. Explain the differences. a. The firm's weighted average cost of capital using book value weights is %. (Round to two decimal places.) Data Table (Click on the icon located on the top-right corner of the data table below in order to copy its contents into a spreadsheet.) Source of capital Long-term debt Preferred stock Common stock equity Totals Book value $4,000,000 40,000 1,060,000 $5,100,000 Market value $4,120,000 66,000 4,887,000 $9,073,000 After-tax cost 8% 13% 15% Print Done

Answer 1

a. Book value weight:

Value (V) = $ 4,000,000 + $ 40,000 + $ 1,060,000

= $ 5,100,000

Debt (D) = $ 4,000,000

Equity (E) = $ 1,060,000

Preferred stock (P) = $ 40,000.

Book value weights

D/V = $ 4,000,000 / $ 5,100,000 = 0.7843

E/V = $ 1,060,000 / $ 5,100,000 = 0.2078

P/V = $ 40,000 / $ 5,100,000 = 0.007843

WACC = D/v * 8 % + E/v * 15 % + P/v * 13 %

= 0.7843 * 8 % + 0.2078 * 15 % + 0.007843 * 13 %

= 0.062745 + 0.031176 + 0.00102

= 0.094941 or 9.4941 %

(b) Market value

Value (V) = $ 4,120,000 + $ 66,000 + $ 4,887,000

= $ 9,073,000

Debt (D) = $ 4,120,000

Equity (E) = $ 4,887,000

Preferred stock (P) = $ 66,000.

Market value weights

D/V = $ 4,120,000 / $ 9,073,000 = 0.454095

E/V = $ 4,887,000 / $ 9,073,000 = 0.538631

P/V = $ 66,000 / $ 9,073,000 = 0.007274

WACC = D/v * 8 % + E/v * 15 % + P/v * 13 %

= 0.454095 * 8 % + 0.538631 * 15 % + 0.007274 * 13 %

= 0.036328 + 0.080795 + 0.000946

= 0.118068 or 11.8068 %

(c) The difference is because of increase in market value of debt , equity and preferred stock. which would increase cost of capital as well.