Quantitative Problem: Barton Industries expects that its target capital structur
ID: 2764151 • Letter: Q
Question
Quantitative Problem: 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 40%. Assume that the firm's cost of debt, rd, is 7.1%, the firm's cost of preferred stock, rp, is 6.6% and the firm's cost of equity is 11.1% for old equity, rs, and 11.41% for new equity, re. What is the firm's weighted average cost of capital (WACC1) if it uses retained earnings as its source of common equity? Round your answer to 3 decimal places. Do not round Intermediate calculations.
%
What is the firm’s weighted average cost of capital (WACC2) if it has to issue new common stock? Round your answer to 3 decimal places. Do not round Intermediate calculations
Explanation / Answer
WACC with retained earnings: The cost of equity to be applied for retained earnings will be 11.1% (Old cost of equity)
After Tax Cost of Debt = Cost of debt x (1-tax rate)
=> 7.1% x (1 – 0.4) = 4.26%
Cost of Preferred Stock = 6.6%
Cost of Equity = 11.1%
WACC = (4.26% x 40%) + (6.6% x 5%) + (11.1% x 55%) = 8.139%
WACC with new equity: The cost of equity to be applied for equity part will be 11.41% (New equity). All other cost will be same as pervious.
WACC = (4.26% x 40%) + (6.6% x 5%) + (11.41% x 55%) = 8.309%