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Weight Average Cost - The Rondo Company

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Requirement A and B
Capital Structure Value Weights Cost of Capital Income Tax After- tax Cost of Capital Weighted Average Cost of Capital
Bank loan 7,500,000 17.26% 6.00% 40% 3.60% 0.62%
Mortgage bond 5,000,000 11.50% 9.00% 40% 5.40% 0.62%
Common stock 30,960,000 71.24% 17.01% 17.01% 12.12%
Total 43,460,000 WACC 13.36%

Bank loan
Interest rate 6.00%
Cost of bank loan 6.00%

Mortgage bond
Interest rate 7.50%
Cost of mortgage bond 9.00%

Common stock
Beta 1.20
Market price 62
Underwriting cost 9

2005 2004 2003
Total dividends paid 1,927,500 1,813,500 1,512,000
Shares outstanding 1,000,000 1,000,000 1,000,000
Dividends per share 1.9275 1.8135 1.512
Annual dividend growth rate 6.29% 19.94%
Compounded annual growth rate 12.91%

Cost of common stock
NOTE: Computing for the cost of common stock using CAPM is NOT possible.
The following variables are not provided in the case:
1. Risk free rate
2. Market risk premium

Computation using the Gordon Growth Model
Cost of equity 17.01%

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Solution Summary

This solution calculates Rondo Company's WACC and MWACC and presents them in a table, then compares them. It is approximately 356 words long.

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The Rondo Company: WACC versus MWACC

First, the weighted average cost of capital (or WACC) is the average cost of capital of a firm based on the weights of the existing capital structure while the marginal weighted average cost of capital (or MWACC) is the cost of capital given that the firm will raise fresh capital and on what type of capital will be raised - debt or equity.

Second, the table below shows Rondo Company's WACC given its existing capital structure and the costs of these ...

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