Peter Johnson, the CFO of Homer Industries, Inc is trying to determine the Weighted Cost of Capital (WACC) based on two different capital structures under consideration to fund a new project. Assume the company’s tax rate is 30%. Component Scenario 1 Scenario 2 Cost of Capital Tax Rate Debt $4,000,000.00 $1,000,000.00 8% 30% Preferred Stock 1,200,000.00 1,500,000.00 10% Common Stock 1,000,000.00 3,700,000.00 13% Total $6,200,000.00 $6,200,000.00 1-a. Complete the table below to determine the WACC for each of the two capital structure scenarios. (Enter your answer as a whole percentage rounded to 2 decimal places (e.g. .3555 should be entered as 35.55).) Senario 1 weight % Senario 2 Weight% Senario 1 Weighted Cost Senario 2 weight cost Cost of capital Tax Rate Debt 64.52 16.13 8% 30% Preferred Stock 19.35 24.19 10% Common Stock 16.13 59.68 13% Total 100.00 100.00 I completed the weights, those were easy but I have been looking at videos on how to calculate WAAC but I am not getting how to accurately come up with the senario 1 and 2 weighted cost for debt, preferred stock, and common stock above. Any help you could provide with a formula explaining how each item gets plugged into the formula would be appreciated. Part two is Assume the new project’s operating cash flows for the upcoming 5 years are as follows: Project A Initial Outlay $ -6,200,000.00 Inflow year 1 1,270,000.00 Inflow year 2 1,750,000.00 Inflow year 3 1,980,000.00 Inflow year 4 2,160,000.00 Inflow year 5 2,450,000.00 WACC ? 2-a. What are the WACC (restated from Part 1), NPV, IRR, and payback years of this project?
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.
Question is
Peter Johnson, the CFO of Homer Industries, Inc is trying to determine the Weighted Cost of Capital (WACC) based on two different capital structures under consideration to fund a new project. Assume the company’s tax rate is 30%.
| Component | Scenario 1 | Scenario 2 | Cost of Capital | Tax Rate |
|---|---|---|---|---|
| Debt | $4,000,000.00 | $1,000,000.00 | 8% | 30% |
| Preferred Stock | 1,200,000.00 | 1,500,000.00 | 10% | |
| Common Stock | 1,000,000.00 | 3,700,000.00 | 13% | |
| Total | $6,200,000.00 | $6,200,000.00 |
1-a. Complete the table below to determine the WACC for each of the two capital structure scenarios. (Enter your answer as a whole percentage rounded to 2 decimal places (e.g. .3555 should be entered as 35.55).)
Senario 1 weight % Senario 2 Weight% Senario 1 Weighted Cost Senario 2 weight cost Cost of capital Tax Rate
Debt 64.52 16.13 8% 30%
Preferred Stock 19.35 24.19 10%
Common Stock 16.13 59.68 13%
Total 100.00 100.00
I completed the weights, those were easy but I have been looking at videos on how to calculate WAAC but I am not getting how to accurately come up with the senario 1 and 2 weighted cost for debt, preferred stock, and common stock above. Any help you could provide with a formula explaining how each item gets plugged into the formula would be appreciated.
Assume the new project’s operating cash flows for the upcoming 5 years are as follows:
| Project A | |
|---|---|
| Initial Outlay | $ -6,200,000.00 |
| Inflow year 1 | 1,270,000.00 |
| Inflow year 2 | 1,750,000.00 |
| Inflow year 3 | 1,980,000.00 |
| Inflow year 4 | 2,160,000.00 |
| Inflow year 5 | 2,450,000.00 |
| WACC | ? |
2-a. What are the WACC (restated from Part 1),
Thank you.
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