WACC and target weights After careful analysis, Dexter Brothers has determined that its optimal capital structure is composed of the sources and target market value weights shown in the following table: The cost of debt is estimated to be 4.8%; the cost of preferred stock is estimated to be 11.8%; the cost of retained earnings is estimated to be 15.3%; and the cost of new common stock is estimated to be 17.3%. All of these are after-tax rates. The company's debt represents 17%, the preferred stock represents 8%, and the common stock equity represents 75% of total capital on the basis of the market values of the three components. The company expects to have a significant amount of retained earnings available and does not expect to sell any new common stock. a. Calculate the weighted average cost of capital on the basis of historical market value weights. b. Calculate the weighted average cost of capital on the basis of target market value weights. c. Compare the answers obtained in parts a and b. Explain the differences. a. The weighted average cost of capital on the basis of historical market value weights is%. (Round to two decimal places.) Data table (Click on the icon here in order to copy the contents of the data table below into a spreadsheet.) Source of capital Long-term debt Preferred stock Common stock equity Total Print Target market value weight 22% 13 65 100% Done o - X
WACC and target weights After careful analysis, Dexter Brothers has determined that its optimal capital structure is composed of the sources and target market value weights shown in the following table: The cost of debt is estimated to be 4.8%; the cost of preferred stock is estimated to be 11.8%; the cost of retained earnings is estimated to be 15.3%; and the cost of new common stock is estimated to be 17.3%. All of these are after-tax rates. The company's debt represents 17%, the preferred stock represents 8%, and the common stock equity represents 75% of total capital on the basis of the market values of the three components. The company expects to have a significant amount of retained earnings available and does not expect to sell any new common stock. a. Calculate the weighted average cost of capital on the basis of historical market value weights. b. Calculate the weighted average cost of capital on the basis of target market value weights. c. Compare the answers obtained in parts a and b. Explain the differences. a. The weighted average cost of capital on the basis of historical market value weights is%. (Round to two decimal places.) Data table (Click on the icon here in order to copy the contents of the data table below into a spreadsheet.) Source of capital Long-term debt Preferred stock Common stock equity Total Print Target market value weight 22% 13 65 100% Done o - X
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Concept explainers
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
Kk.372.
Transcribed Image Text:WACC and target weights After careful analysis, Dexter Brothers has determined that its optimal capital structure is composed of the sources
and target market value weights shown in the following table:
The cost of debt is estimated to be 4.8%; the cost of preferred stock is estimated to be 11.8%; the cost of retained earnings is estimated to be
15.3%; and the cost of new common stock is estimated to be 17.3%. All of these are after-tax rates. The company's debt represents 17%, the
preferred stock represents 8%, and the common stock equity represents 75% of total capital on the basis of the market values of the three
components. The company expects to have a significant amount of retained earnings available and does not expect to sell any new common
stock.
a. Calculate the weighted average cost of capital on the basis of historical market value weights.
b. Calculate the weighted average cost of capital on the basis of target market value weights.
c. Compare the answers obtained in parts a and b. Explain the differences.
a. The weighted average cost of capital on the basis of historical market value weights is %. (Round to two decimal places.)
Data table
(Click on the icon here in order to copy the contents of the data table below
into a spreadsheet.)
Source of capital
Long-term debt
Preferred stock
Common stock equity
Total
Print
Target market
value weight
22%
13
65
100%
Done
-
X
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