7. Sweetest Chocolate Co. wants to determine the minimum cost of capital point f
ID: 2696644 • Letter: 7
Question
7. Sweetest Chocolate Co. wants to determine the minimum cost of capital point for the firm. Assume it is considering the following financial plans?
a. Which of the four plans has the lowest weighted average cost of capital?
b. Briefly discuss the results from Plan C and Plan D, and why one is better than the other.
Cost (aftertax)
This goes with the first column of percentages.
Weights
This goes with the second column of percentages.
Plan A
Debt
5.0%
20%
Preferred Stock
10.0%
10%
Common Equity
14.0%
70%
Plan B
Debt
5.5%
30%
Preferred Stock
10.5%
10%
Common Equity
15.0%
60%
Plan C
Debt
6.0%
40%
Preferred Stock
10.7%
10%
Common Equity
15.8%
50%
Plan D
Debt
8.0%
50%
Preferred Stock
11.2%
10%
Common Equity
17.5%
40%
Cost (aftertax)
This goes with the first column of percentages.
Weights
This goes with the second column of percentages.
Plan A
Debt
5.0%
20%
Preferred Stock
10.0%
10%
Common Equity
14.0%
70%
Plan B
Debt
5.5%
30%
Preferred Stock
10.5%
10%
Common Equity
15.0%
60%
Plan C
Debt
6.0%
40%
Preferred Stock
10.7%
10%
Common Equity
15.8%
50%
Plan D
Debt
8.0%
50%
Preferred Stock
11.2%
10%
Common Equity
17.5%
40%
Explanation / Answer
WACC of Plan A=(5x.2)+(10x.1)+(14x.7)=11.8%
WACC of Plan B= (5.5x.3)+(10.5x.1)+(15x.6)=11.7%
WACC of Plan C= (6x.4)+(10.7x.1)+(15.8x.5)= 11.37%
WACC of Plan D= (8x.5)+(11.2x.1)+(17.5x.4)= 12.12%
a) Plan C has the lowest WACC.
b) The WACC of plan D is more than the WACC of plan C, since PlanD uses more debt(50%) than plan C, which uses only 40% of Debt
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