Question

Compute the weighted average cost of capital for each of these firms. Match them with the correct letter. Assume a marginal tax rate of 40 percent.

Target capital structure is 60% debt and 40% common equity. Yield to maturity on bonds is 8.5% and expected return on common equity is 11.1%.

Target capital structure is 70% debt and 30% common equity. Yield to maturity on bonds is 6.7% and expected return on common equity is 11.5%.

Target capital structure is 10% debt and 90% common equity. Yield to maturity on bonds is 4.5% and expected return on common equity is 8.9%.

Target capital structure is 60% debt and 40% common equity. Yield to maturity on bonds is 5.9% and expected return on common equity is 12.1%.

Target capital structure is 20% debt and 80% common equity. Yield to maturity on bonds is 6.5% and expected return on common equity is 10.0%.

A. 6.3%

B. 8.3%

C. 7.5%

D. 7.0%

E. 8.8%

Answer 1

Target capital structure is 60% debt and 40% common equity. Yield to maturity on bonds is 8.5% and expected return on common equity is 11.1%.

.60(1-.40)*8.5+.40*11.1=7.5% Option C

Target capital structure is 70% debt and 30% common equity. Yield to maturity on bonds is 6.7% and expected return on common equity is 11.5%.

.70(1-.4)*6.7+.30*11.5=6.3% OPtion A

Target capital structure is 10% debt and 90% common equity. Yield to maturity on bonds is 4.5% and expected return on common equity is 8.9%.

.10(1-.4)*4.5+.9*8.9=8.3% option B

Target capital structure is 60% debt and 40% common equity. Yield to maturity on bonds is 5.9% and expected return on common equity is 12.1%.

.60(1-.4)*5.9+.4*12.1=7.0% option D

Target capital structure is 20% debt and 80% common equity. Yield to maturity on bonds is 6.5% and expected return on common equity is 10.0%.

.20*(1-.4)*6.5+.8*10=8.8% option E