Barton Industries expects that its target capital structure

Barton Industries expects that its target capital structure for raising funds in the future for its capital budget will consist of 40% debt, 5% preferred stock, and 55% common equity. Note that the firm\'s marginal tax rate is 40%. Assume that the firm\'s cost of debt, rd, is 7.5%, the firm\'s cost of preferred stock, rp, is 7% and the firm\'s cost of equity is 11.5% for old equity, rs, and 12.08% for new equity, re. What is the firm\'s weighted average cost of capital (WACC1) if it uses retained earnings as its source of common equity? Round your answer to 3 decimal places. Do not round intermediate calculations. % What is the firm’s weighted average cost of capital (WACC2) if it has to issue new common stock? Round your answer to 3 decimal places. Do not round intermediate calculations. %

Solution

WACC = Weight of debt * Cost of debt * (1 - Tax Rate) + Weight of preferred equity * Cost of preferred equity + Weight of Common equity * Cost of common equity

WACC - Retained earnings

WACC = (40% * 7.5% * (1 - 40%)) + (5% * 7%) + (55% * 11.5%)

WACC = 1.8% + 0.35% + 6.325%

WACC1 = 8.475%

WACC - New Equity Issuance

WACC = (40% * 7.5% * (1 - 40%)) + (5% * 7%) + (55% * 12.08%)

WACC = 1.8% + 0.35% + 6.644%

WACC2 = 8.794%