Turnbull Co. has a target capital structure of 45% debt, 4% preferred stock, and

Question

Turnbull Co. has a target capital structure of 45% debt, 4% preferred stock, and 51% common equity. It has a before*tax cost of debt of 11.1%, and its cost of preferred stock is 12.2%. If Turnbull can raise all of its equity capital from retained earnings, its cost of common equity will be 14.7%. However, if it is necessary to raise new common equity, it will carry a cost of 16.8%. If its current tax rate is 40%, how much higher will Turnbull's weighted average cost of capital (WACC) be if it has to raise additional common equity capital by issuing new common stock instead of raising the funds through retained earnings? Turnbull Co. is considering a project that requires an initial investment of $1,708,000. The firm will raise the $1 708 000 in capital by issuing $750,000 of debt at a before-tax cost of 9.6%, $78,000 of preferred stock at a cost of 10.7%, and $880,000 of equity at a cost of 13.5%. The firm faces a tax rate of 40%. What will be the WACC for this project?

Explanation / Answer

1)correct option is "D"

[ .51 (16.8-14.7) ] = [.51 * 2.1 ] = 1.07

2)WACC =[After tax cost of debt *Wd) +(cost of preferred stock *Wp )+(cost of equity *We)

                [9.6(1-.40)*750000/1708000] + (10.7 * 78000/ 1708000)+(13.50*880000/ 1708000)

              [5.76 * .4391 ] + [ 10.7 * .0457) +(13.5 * .5152]

             2.53 + .489 + 6.955

            = 9.97%

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