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