Chapter 10, Problem 11P

Summary Introduction

To determine: The percentage of the company’s capital structure consists of debt.

Introduction:

Weighted Average Cost of Capital (WACC):

It is the weighted average cost of all the sources through which the firm finances its capital. It is the rate that a company will pay to all for raising finance. It can be termed as the firm’s cost of capital. The company raises money through various sources such as common stock and preference share debt. The WACC is calculated by taking the relative weight of each item of capital structure.

Formula to calculate the WACC is,

$\text{WACC}={\text{W}}_{\text{d}}{\text{r}}_{\text{d}}\left(1-\text{t}\right)+{\text{W}}_{\text{P}}{\text{r}}_{\text{p}}+{\text{W}}_{\text{c}}{\text{r}}_{\text{s}}$

Where,

• ${\text{W}}_{\text{d}}$ is the weight of the debt.
• ${\text{W}}_{\text{P}}$ is the weight of the preferred stock.
• ${\text{W}}_{\text{c}}$ is the weight of the equity.
• ${\text{r}}_{\text{d}}$ is cost of the debt.
• ${\text{r}}_{\text{P}}$ is cost of the preferred stock.
• ${\text{r}}_{\text{c}}$ is the cost of the equity.