A company has target values of debt, preferred and common of $23MM, $16MM and $8

Question

A company has target values of debt, preferred and common of $23MM, $16MM and $85MM. It has book values of debt, preferred and common of $66MM, $7MM and $18MM. It also has liquidation values of debt, preferred and common of $38MM, $19MM and $6MM. What weights should it use for purposes of estimating WACC?

Debt 60.3%; Preferred 30.2%; Common 9.5%

debt 23.4%; Preferred 46.2%; Common 31.4%

Debt 18.6%; Preferred 12.9%; Common 68.5%

Debt 72.5%; Preferred 7.7%; Common 19.8%

As a company changes its target capital structure to include a greater percentage of common equity, its WACC will:

Decrease

Increase

Remain unchanged

Cannot say

Debt 60.3%; Preferred 30.2%; Common 9.5%

debt 23.4%; Preferred 46.2%; Common 31.4%

Debt 18.6%; Preferred 12.9%; Common 68.5%

Debt 72.5%; Preferred 7.7%; Common 19.8%

Explanation / Answer

Liquidation values should be used for WACC:

Hence, correct option is Debt 60.3%; Preferred 30.2%; Common 9.5% (Option (a))

Since, common stock book value is higher than market value, WACC will increase.

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