Purchase Solution

# Solve for weighted average cost of capital and market value.

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The following are balance sheets for the Genatron Manufacturing Corporation for the years 2010 and 2011:

Balance Sheet 2010 2011
Cash \$50,000 \$40,000
Accounts receivable 200,000 260,000
Inventory 450,000 500,000
Total current assets 700,000 800,000
Fixed assets (net) 300,000 400,000
Total assets \$1,000,000 \$1,200,000
Bank loan, 10% \$ 90,000 \$ 90,000
Accounts payable 130,000 170,000
Accruals 50,000 70,000
Total current liabilities \$270,000 \$330,000
Long-term debt, 12% 300,000 400,000
Common stock, \$10 par 300,000 300,000
Capital surplus 50,000 50,000
Retained earnings 80,000 120,000
Total liabilities and equity \$1,000,000 \$1,200,000

a. Calculate the weighted average cost of capital based on book value weights. Assume an after-tax cost of new debt of 8.63 percent and a cost of common equity of 16.5 percent.

b. The current market value of Genatron's long-term debt is \$350,000. The common stock price is \$20 per share and there are 30,000 shares outstanding. Calculate the WACC using market value weights and the component capital costs in (a).

c. Recalculate the WACC based on both book value and market value weights assuming that the before-tax cost of debt will be 18 percent, the company is in the 40 percent income tax bracket, and the after-tax cost of common equity capital is 21 percent.

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The expert solves for weighted average cost of capital and market values.

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a) Given that,
Total long term Debt=\$300,000=\$300,000
Total Common Equity=\$300,000+\$50,000+\$80,000=\$300,000
Now,
Weight of debt in capital structure=\$300,000/(\$300,000+\$430,000)=41.10%
Weight of Equity in Cpaital ...

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• MBA, Indian Institute of Finance
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