Question

Williams, Inc., has compiled the following information on its financing costs:

  

Type of Financing	Book Value			Market Value			Cost
Short-term debt	$	13,600,000		$	13,300,000		3.5	%
Long-term debt		32,000,000			30,200,000		6.6
Common stock		10,600,000			78,000,000		12.4
Total	$	56,200,000		$	121,500,000

  

The company is in the 23 percent tax bracket and has a target debt-equity ratio of 75 percent. The target short-term debt/long-term debt ratio is 10 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? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

    

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

    

• Market weights

• Target weights

• Book weights

Answer 1

	Book Value	Weights	Market Value	Weights	Target Weights	Cost
Short-term debt	13,600,000	24.2%	13,300,000	10.9%	3.9%	3.5
Long-term debt	32,000,000	56.9%	30,200,000	24.9%	39.0%	6.6
Common stock	10,600,000	18.9%	78,000,000	64.2%	57.1%	12.4
Total	56,200,000		121,500,000

Calculate the weights of each component by dividing the value by total.

Using Book Value, WACC = (24.2% x 3.5% + 56.9% x 6.6%) x (1 - 23%) + 18.9% x 12.4% = 5.88%

Using Market Value, WACC = (10.9% x 3.5% + 24.9% x 6.6%) x (1 - 23%) + 64.2% x 12.4% = 9.52%

Using target weights, WACC = 9.17%

We should use target weights while evaluating projects.