Quantitative Problem: Barton Industries expects that its target capital structur
ID: 2764643 • 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 = rd * weight of debt + rp * weight of preferred stock + re * weight of equity
rd = after tax cost of debt = 7.10 * (1-.40) = 4.26%
Firm's weighted average cost of capital (WACC1) if it uses retained earnings as its source of common equity:
WACC = 4.26% * 40% + 6.60% * 5% + 11.10% * 55%
= 1.704% + .33% + 6.105% = 8.139%
Firm’s weighted average cost of capital (WACC2) if it has to issue new common stock:
WACC = 4.26% * 40% + 6.60% * 5% + 11.41% * 55%
= 1.704% + .33% + 6.2755% = 8.3095% = 8.310%