Sauer Milk Inc. wants to determine the minimum cost of capital point for the fir

Question

Sauer Milk Inc. wants to determine the minimum cost of capital point for the firm. Assume it is considering the following financial plans: Cost (aftertax) Weights Plan A Debt 6.0 % 25 % Preferred stock 12.0 15 Common equity 20.0 60 Plan B Debt 6.2 % 35 % Preferred stock 12.2 15 Common equity 17.0 50 Plan C Debt 7.0 % 45 % Preferred stock 16.7 15 Common equity 12.6 40 Plan D Debt 14.0 % 55 % Preferred stock 17.6 15 Common equity 14.6 30 Compute the weighted average cost for four plans. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.) Weighted Cost Plan A % Plan B % Plan C % Plan D % a-2.

Explanation / Answer

Answer:

Weighted Average Cost of Capital = (Weight of Debt * Cost of Debt) + (Weight of Preferred Stock * Cost of Preferred Stock) + (Weight of Common Equity * Cost of Common Equity)

Plan A:
Weighted Average Cost of Capital = (0.25 * 0.06) + (0.15 * 0.12) + (0.60 * 0.20)
Weighted Average Cost of Capital = 0.015 + 0.018 + 0.12
Weighted Average Cost of Capital = 0.153 or 15.3%

Plan B:
Weighted Average Cost of Capital = (0.35 * 0.062) + (0.15 * 0.122) + (0.50 * 0.17)
Weighted Average Cost of Capital = 0.0217 + 0.0183 + 0.085
Weighted Average Cost of Capital = 0.125 or 12.5%

Plan C:
Weighted Average Cost of Capital = (0.45 * 0.07) + (0.15 * 0.167) + (0.40 * 0.126)
Weighted Average Cost of Capital = 0.0315 + 0.02505 + 0.0504
Weighted Average Cost of Capital = 0.10695 or 10.70%

Plan D:
Weighted Average Cost of Capital = (0.55 * 0.14) + (0.15 * 0.176) + (0.30 * 0.146)
Weighted Average Cost of Capital = 0.077+ 0.0264 + 0.0438
Weighted Average Cost of Capital = 0.1472 or 14.72%

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