Barton Industries expects that its target capital structure for raising funds in
ID: 2713034 • Letter: B
Question
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 7.3%, the firm's cost of preferred stock, rp, is 6.8% and the firm's cost of equity is 11.3% for old equity, rs, and 11.86% for new equity, re.
a.) 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.
b.)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
=
E
×
re
+
D
×
(1 t)
×
rd
+
P
×
rp
(E+D+P)
(E+D+P)
(E+D+P)
Where:
E
=
Market value of equity
D
=
Market value of debt
P
=
Market value of preferred stock
re
=
Cost of equity
rd
=
Cost of debt
rp
=
Cost of preferred stock
t
=
Marginal tax rate
WACC1= .05*6.8 + .4 *(1 - 0.4)*7.3 + .55*11.3
=8.307%
WACC2= .05*6.8 + .4 *(1 - 0.4)*7.3 + .55*11.86
= 8.615%
WACC
=
E
×
re
+
D
×
(1 t)
×
rd
+
P
×
rp
(E+D+P)
(E+D+P)
(E+D+P)
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