Chapter 13, Problem 8QP

a.

Summary Introduction

To determine: The WACC.

Answer to Problem 8QP

The WACC is 11.27%.

Explanation of Solution

Determine the WACC

$\begin{array}{c}WACC=\left[\begin{array}{l}\left(\left(Weigh{t}_{Debt}\times Rat{e}_{Debt}\right)\times \left(1-Tax\right)\right)+\left(Weigh{t}_{\mathrm{Pr}eferredStock}\times Rat{e}_{\mathrm{Pr}eferredStock}\right)+\\ \left(Weigh{t}_{Equity}\times Rat{e}_{Equity}\right)\end{array}\right]\\ =\left[\left(\left(24.30\%\times 9\%\right)\times \left(1-0\%\right)\right)+\left(75.70\%\times 12\%\right)\right]\\ =\left[0.02187+0.09084\right]\\ =0.11271or11.27\%\end{array}$

Therefore, the WACC is 11.27%.

b.

Summary Introduction

To determine: The cost of equity.

Answer to Problem 8QP

The cost of equity is 12.60%.

Explanation of Solution

Determine the weight of debt and equity

$\begin{array}{c}WeightofDebt=\left[\frac{ValueofDebt}{MarketValueofDebt}\right]\\ =\left[\frac{\$385.7million+\$200million}{\$1,585.70million}\right]\\ =0.369364or36.94\%\end{array}$

$\begin{array}{c}WeightofEquity=\left[\frac{ValueofDebt}{MarketValueofDebt}\right]\\ =\left[\frac{\$1,200million-\$200million}{\$1,585.70million}\right]\\ =0.630636or63.06\%\end{array}$

Therefore, the weight of debt is 36.94% and the weight of equity is 63.06%.

Determine the cost of equity

$\begin{array}{c}WACC=\left[\left(\left(Weigh{t}_{Debt}\times Rat{e}_{Debt}\right)\times \left(1-Tax\right)\right)+\left(Weigh{t}_{Equity}\times Rat{e}_{Equity}\right)\right]\\ 11.27\%=\left[\left(\left(36.94\%\times 9\%\right)\times \left(1-0\%\right)\right)+\left(63.06\%\times Rat{e}_{Equity}\right)\right]\\ Rat{e}_{Equity}=\left[\frac{0.079454}{0.6306}\right]\\ =0.125997or12.60\%\end{array}$

Therefore, the cost of equity is 12.60%.