Question

Quantitative Problem: Barton Industries expects that its target capital structure for raising funds in the future for its capital budget will consist of 40% debt, 5% preferred stock, and 55% common equity. Note that the firm's marginal tax rate is 40%. Assume that the firm's cost of debt, r_d, is 7.7%, the firm's cost of preferred stock, r_ps, is 7.2% and the firm's cost of equity is 11.7% for old equity, r_s, and 12.38% for new equity, r_e. What is the firm's weighted average cost of capital (WACC₁) if it uses retained earnings as its source of common equity? Round your answer to 3 decimal places. Do not round intermediate calculations.
%

What is the firm’s weighted average cost of capital (WACC₂) if it has to issue new common stock? Round your answer to 3 decimal places. Do not round intermediate calculations.
%

Answer 1

1)

WACC1 = Weight of debt*after tax cost of debt + weight of preferred stock*cost of preferred stock + weight of equity*cost of old equity

WACC1 = 0.4*0.077*(1 - 0.4) + 0.05*0.072 + 0.55*0.117

WACC1 = 0.01848 + 0.0036 + 0.06435

WACC1 = 0.08643 or 8.643%

2)

WACC2 = Weight of debt*after tax cost of debt + weight of preferred stock*cost of preferred stock + weight of equity*cost of old equity

WACC2 = 0.4*0.077*(1 - 0.4) + 0.05*0.072 + 0.55*0.1238

WACC2 = 0.01848 + 0.0036 + 0.06809

WACC2 = 0.09017 or 9.017%