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# Cost of capital (WACC)

The CFO has asked you to recompute the ABC's weighted average cost of capital based upon three different financing scenarios. Tax rate of 40%

Current financial structure is \$4,500,000 debt at an average interest rate of 8.5% and common equity of \$2,500,000 with a required return of 16%.

Scenario 1 is to add \$1,500,000 of debt that will cost 12%.

Scenario 2 is to add \$1,000,000 of debt at 10.25% and \$500,000 of equity at 16%.
Scenario 3 is to add \$500,000 of debt at 9%, \$500,000 of preferred stock that will return 12% and \$500,000 of equity to return 16%. There are no floatation costs.

#### Solution Preview

Total current finances are \$4,500,000 debt and common equity of \$2,500,000.
= \$4,500,000 + \$2,500,000 = \$7,000,000
The target proportions of debt (wd) = 4,500,000 / 7,000,000 = 0.642857
The target proportions of common equity (wc) =2,500,000 / 7,000,000 = 0.35714

WACC = wd rd (1 - T) + wp rp + wcrs
= 0.642857 (8.5%) (1 - 0.4) + 0 + 0.35714 (16%)
= 0.642857 (8.5%) (0.6) + 0 + 0.35714 (16%)
= 3.279% + 0 + 5.71424%
= 8.99%

Scenario 1:

Total new finances are (\$4,500,000 + \$1,500,000) debt and common equity of \$2,500,000.
= ...

#### Solution Summary

This solution is comprised of a step-by-step calculations of cost of capital (WACC).

\$2.19