A company decides to fund its investment from the sources listedbelow. Sources F
ID: 1237491 • Letter: A
Question
A company decides to fund its investment from the sources listedbelow.Sources Funding
Loan $3,750,000
Bonds
$750,000
Common Stock
$5,000,000
Retained Earnings
$500,000
The loan has a before-tax annual rate of 10.25%. the bondshave an after-tax effective annual rate of 7%. the stock price isstable and currently trading at $200/share with a $14 annualdividend. the company is in a 35% tax bracket and pays taxesannually. Determine the Weighted average cost of capital.
Sources Funding
Loan $3,750,000
Bonds
$750,000
Common Stock
$5,000,000
Retained Earnings
$500,000
Explanation / Answer
Sources Funding
Loan $3,750,000
Bonds $750,000
Commonstock $5,000,000
RetainedEarnings $500,000
----------------
TOTAL $10,000,000
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Before-tax cost of loan = 10.25%
After-tax cost of loan = 0.1025 * 0.65
After-tax cost of loan = 0.0666(or) 6.66%
After-tax cost of loan = 6.66%
After-tax cost of bond = 7%
WACC =[ ($3,750,000 / $10,000,000) * 0.0666 + ($750,000 /$10,000,000) * 0.07
+ ($5,000,000 / 10,000,000) * 0.07 +($500,000 / $10,000,000) * 0.07 ]
WACC = [(0.375 * 0.0666) + (0.075 * 0.07) + (0.50 *0.07) + (0.05 * 0.07)]
WACC = [0.024975 + 0.00525 + 0.035 + 0.0035]
WACC = 0.068725 (or) 6.87%
Weighted Average Cost of Capital(WACC) = 6.87%
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