Question

Williams, Inc., has compiled the following information on its financing costs: Type of Financing Book Value Market Value Cost Short-term debt $ 13,000,000 $ 13,000,000 3.2 % Long-term debt 27,500,000 27,500,000 6.3 Common stock 10,000,000 69,000,000 12.1 Total $ 50,500,000 $ 109,500,000 The company is in the 25 percent tax bracket and has a target debt-equity ratio of 60 percent. The target short-term debt/long-term debt ratio is 20 percent.

a. What is the company’s weighted average cost of capital using book value weights? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

b. What is the company’s weighted average cost of capital using market value weights? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

c. What is the company’s weighted average cost of capital using target capital structure weights?

d.	Which is the correct WACC to use for project evaluation?

Answer 1

a). WACC = [wSTD x kSTD x (1 - t)] + [wLTD x kLTD x (1 - t)] + [wE x kE]

= [(13/50.5) x 3.2% x (1 - 0.25)] + [(27.5/50.5) x 6.3% x (1 - 0.25)] + [(10/50.5) x 12.1%]

= 0.62% + 2.57% + 2.40% = 5.59%

b). WACC = [wSTD x kSTD x (1 - t)] + [wLTD x kLTD x (1 - t)] + [wE x kE]

= [(13/109.5) x 3.2% x (1 - 0.25)] + [(27.5/109.5) x 6.3% x (1 - 0.25)] +

[(69/109.5) x 12.1%]

= 0.28% + 1.19% + 7.62% = 9.10%

c). WACC = [wSTD x kSTD x (1 - t)] + [wLTD x kLTD x (1 - t)] + [wE x kE]

= [{(0.2/1.2)x(0.6/1.6)} x 3.2% x (1 - 0.25)] + [{(1/1.2)x(0.6/1.6)} x 6.3% x (1 - 0.25)]

+ [(1/1.6) x 12.1%]

= 0.15% + 1.48% + 7.56% = 9.19%

d). Market Value weight wacc is best suited for project evaluation.