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Cost of capital (WACC)

Please show calculations.

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 ...

Solution Summary

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

$2.19