Question

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 25%. Assume that the firm's cost of debt, r_d, is 6.9%, the firm's cost of preferred stock, r_ps, is 6.4% and the firm's cost of equity is 10.9% for old equity, r_s, and 11.5% 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? Do not round intermediate calculations.

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

Answer 1

1)

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

weighted average cost of capital (WACC1) = 0.4*0.069*(1 - 0.25) + 0.05*0.064 + 0.55*0.109

weighted average cost of capital (WACC1) = 0.0207 + 0.0032 + 0.05995

weighted average cost of capital (WACC1) = 0.0839 or 8.39%

2)

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

weighted average cost of capital (WACC2) = 0.4*0.069*(1 - 0.25) + 0.05*0.064 + 0.55*0.115

weighted average cost of capital (WACC2) = 0.0207 + 0.0032 + 0.06325

weighted average cost of capital (WACC2) = 0.0872 or 8.72%