WACC- Book weights and market weights. Webster Company has compiled the informat

Question

WACC- Book weights and market weights. Webster Company has compiled the informaton shown in the following table:

a.) Calculate the weighted average cost of capital using book value weights.

b.) Calculate the weighted average cost of capital usign market value weights.

c.) Compared the answers obtained in parts A and B. Explain the differences.

Source of capital book value Market value After Tax cost Long term debt $4,000,000 $4,200,000 8% Preferred stock 40,000 64,000 12% Common stock equity 1,060,000 3,116,000 18% Totals $5,100,000 $7,380,000

Explanation / Answer

Book Value weights Market Value weights

Long Term Debt $ 4,000,000 0.784 $ 4,200,000 0.569

Preferred stock $ 40,000 0.008 64,000 0.009

Common stock $ 1,060,000 0.208 3,116,000 0.422

WACC book value 0.784*0.08+0.008*0.12+0.208*0.18=0.0627+0.00096+0.03744=0.10110 or 10.11%

WACC market value =0.569*0.08+0.009*0.12+0.422*0.18=0.04552+0.00108+0.07596=0.12256 or 12.26%

the difference the WACCs of book value and market value is because of the differences the values ,all the market values are greater than the book values.

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