Company stated that its optimal capital structure consists of debt taking up 30% of its total capital. B Company's existing and target capital structure is as shown. Source of Capital Target Weights Existing Weights Cost of Source Long Term Debt 30% 10% 8% Preferred Stock 15% 15% 13% Common Stock Equity 55% 75% 15% 1. Calculate target and existing WACC 2a. Should B Company continue moving towards its target WACC? Why or why not? 2b. How could increasing debt be beneficial for B Comp?
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
B Company stated that its optimal capital structure consists of debt taking up 30% of its total capital. B Company's existing and target capital structure is as shown.
| Source of Capital | Target Weights | Existing Weights | Cost of Source |
| Long Term Debt | 30% | 10% | 8% |
| 15% | 15% | 13% | |
| Common Stock Equity | 55% | 75% | 15% |
1. Calculate target and existing WACC
2a. Should B Company continue moving towards its target WACC? Why or why not?
2b. How could increasing debt be beneficial for B Comp?
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