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 7.9%, the firm's cost of preferred stock, r_p, is 7.4% and the firm's cost of equity is 11.9% for old equity, r_s, and 12.58% 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)

weighted average cost of capital (WACC1) = Weights * costs

weighted average cost of capital (WACC1) = 0.4*0.079*(1 - 0.4) + 0.05*0.074 + 0.55*0.119

weighted average cost of capital (WACC1) = 0.01896 + 0.0037 + 0.06545

weighted average cost of capital (WACC1) = 0.08811 or 8.811%

2)

weighted average cost of capital (WACC2) = Weights * costs

weighted average cost of capital (WACC2) = 0.4*0.079*(1 - 0.4) + 0.05*0.074 + 0.55*0.1258

weighted average cost of capital (WACC2) = 0.01896 + 0.0037 + 0.06919

weighted average cost of capital (WACC2) = 0.09185 or 9.185%