Question

​(Weighted average cost of​ capital)  As a member of the Finance Department of Ranch​ Manufacturing, your supervisor has asked you to compute the appropriate discount rate to use when evaluating the purchase of new packaging equipment for the plant. Under the assumption that the​ firm's present capital structure reflects the appropriate mix of capital sources for the​ firm, you have determined the market value of the​ firm's capital structure as​ follows:

Source of Capital	Market Values
Bonds	$3,600,000
Preferred stock	$1,800,000
Common stock	$6,500,000

To finance the​ purchase, Ranch Manufacturing will sell 10-year bonds paying interest at a rate of 7.1 percent per year​ (with semiannual​ payment) at the market price of $1,053. Preferred stock paying a $2.08 dividend can be sold for $24.06. Common stock for Ranch Manufacturing is currently selling for $55.38 per share and the firm paid a $2.91 dividend last year. Dividends are expected to continue growing at a rate of 5.1 percent per year into the indefinite future. If the​ firm's tax rate is 30 percent, what discount rate should you use to evaluate the equipment​ purchase?

a.  Calculate component weights of capital.

The weight of debt in the​ firm's capital structure is?

The weight of preferred stock in the​ firm's capital structure is?

The weight of common stock in the​ firm's capital structure is?

b.  Calculate component costs of capital.

The​ after-tax cost of debt for the firm is?

The cost of preferred stock for the firm is?

The cost of common equity for the firm is?

c.  Calculate the​ firm's weighted average cost of capital.

The discount rate you should use to evaluate the equipment purchase is?

Answer 1

1.
=3600000/(3600000+1800000+6500000)=30.2521008403361%

2.
=1800000/(3600000+1800000+6500000)=15.1260504201681%

3.
=6500000/(3600000+1800000+6500000)=54.6218487394958%

4.
=RATE(10*2,7.1%*1000/2,-1053,1000)*2*(1-30%)=4.46257128636324%

5.
=2.08/24.06=8.6450540315877%

6.
=2.91*(1+5.1%)/55.38+5.1%=10.6225893824485%

7.
=(3600000*(RATE(10*2,7.1%*1000/2,-1053,1000)*2*(1-30%))+1800000*(2.08/24.06)+6500000*(2.91*(1+5.1%)/55.38+5.1%))/(3600000+1800000+6500000)=8.45993150199%