Cost of capital schedule (one break point) A company plans to raise new capital
ID: 2643445 • Letter: C
Question
Cost of capital schedule (one break point) A company plans to raise new capital as follows:
Cost Proportion
Bonds payable 9% 35%
Preferred Stock 15.5 15
Common stock (retained earnings) 17.5 50
Total liabilities + equity 100%
The firm forcasts it can retain 1 million of new earnings. If it requires additional common equity, it will sell a new issue of common stock at a cost of 18.5%.
Calculate the companys WACC using new retained earnings as the equity source.
Explanation / Answer
Since the value of Bonds and Preferred Stock is not given , it is not possible to find out the impact of the 1m new earning on the capital structure. Therefore , with the same capital structure and the cost of new equity @18.5% , ( Assuming equal 50% retained earning and 50% new equity ) we have calculated the existing and new WACC as follows:
Existing WACC=0.35*9+0.15*15.5+0.5*17.5=14.225
New WACC=0.35*9+0.15*15.5+0.25*17.5+0.25*18.5=14.475