Part One: Quantitative Exercises Barbow Enterprises, Inc., is considering an exp
ID: 2702259 • Letter: P
Question
Part One: Quantitative Exercises
Barbow Enterprises, Inc., is considering an expansion in their operations. One of the first items they want to examine is their cost of capital. According to the accounting department, the following items and their respective costs have been identified:
%u2022 The cost of Common Equity: 15%
%u2022 The before tax cost of debt: 12%
%u2022 No Preferred stock
They have also calculated the marginal tax rate to be 40% and the stock sells at its book value.
Barbow Enterprises Inc.
Balance Sheet
Assets Liabilities and Owners' Equity
Cash $240 Long Term Debt $2,304
Accounts Receivable 480 Equity 3,456
Inventories 720
Net P&E 4,320
Total Assets $5,760 Total Liabilities and owners' Equity $5,760
Required:
Calculate Barbow%u2019s after-tax weighted average cost of capital, using the data in the balance sheet above.
Explanation / Answer
Cost of equity = 15%
Cost of after tax debt = 12*(1-0.40) = 7.20%
Weight of Equity = 3456/5760 = 0.60
Weight of debt = 2304/5760 = 0.40
Barbows after-tax weighted average cost of capital,= 15*0.60 + 7.20*0.40 = 11.88%