InterCont is a construction company that plans on purchasing new equipment this

Question

InterCont is a construction company that plans on purchasing new equipment this year for a new project. The project is expected to return $700,000 per year for the next 5 years. The equipment needed will cost $5,000,000. In order to purchase this equipment, InterCont must acquire the necessary funds from several sources.

The following list shows the proportion of funds expected from each source, and the rate of interest (or similar cost) that will be required for each source:

Bond issuance: 30% of total funds, requires 10% interest per year
Bank loan: 50% of total funds, requires 15% interest per year
Preferred Stock issuance: 20% of total funds, requires 7% dividend per year

What is the weighted average cost of capital from the financing sources?

Explanation / Answer

Assumption: Ignoring Taxes Weighted average cost of Capital = Cost of bond * % bonds + Cost of bank loan * % of bank loan +Cost of preferred stock * % of preferred stock = 0.1*0.3 + 0.15 * 0.5 +0.07 *0.2 = 0.119 ~ 11.9%

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