The Rawlings Company has a target capital structure of 50 percent common equity,

Question

The Rawlings Company has a target capital structure of 50 percent common equity, 40 percent debt, and 10 percent preferred stock. The cost of retained earnings is 16 percent, and the cost of new equity (external) is 16.7 percent. Princeton can sell debentures (bonds) that will have an after-tax cost of 8.3 percent and the after-tax cost of preferred stock will be 11.9 percent. What is the marginal cost of capital (WACC) if only retained earnings common equity is used? What is the marginal cost of capital (WACC) if newly issued common equity is used?

Explanation / Answer

WACC(retained earnings) = 0.5*16 + 0.4*8.3 + 0.1*11.9 = 12.51%

WACC (new common equity) = 0.5*16.7 + 0.4*8.3 + 0.1*11.9 =12.86%

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