Barton Industries expects that its target capital structure for raising funds in

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 7.5%, the firm's cost of preferred stock, rp, is 7% and the firm's cost of equity is 11.5% for old equity, rs, and 12.08% for new equity, re. 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. % 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 = Weight of debt * Cost of debt * (1 - Tax Rate) + Weight of preferred equity * Cost of preferred equity + Weight of Common equity * Cost of common equity

WACC - Retained earnings

WACC = (40% * 7.5% * (1 - 40%)) + (5% * 7%) + (55% * 11.5%)

WACC = 1.8% + 0.35% + 6.325%

WACC1 = 8.475%

WACC - New Equity Issuance

WACC = (40% * 7.5% * (1 - 40%)) + (5% * 7%) + (55% * 12.08%)

WACC = 1.8% + 0.35% + 6.644%

WACC2 = 8.794%

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