Question

J & B Corp. is investing in a major capital budgeting project that will require the expenditure of $20 million. The money will be raised by issuing $5 million of bonds, $3 million of preferred stock, and $12 million of new common stock. The company estimates is after-tax cost of debt to be 5%, its cost of preferred stock to be 9%, the cost of retained earnings to be 13%, and the cost of new common stock to be 16%. What is the weighted average cost of capital for this project?a)12.20%b)11.90%c)10.75%d)10.00%

Answer 1

a) 12.20%

Step-by-step explanation:

For calculating the WACC which is termed as weighted average cost of capital, will be calculated here by taking out weighted proportion of each bonds, preferred stock and new common stock and multiplying these weighted proportion by the cost of debt, cost of preferred stock and cost of new common equity respectively. And at last we will add all three of them.

WACC = weightage of debt x cost of debt

+

weightage of preferred stock x cost of preferred stock

+

weightage of common stock x cost of common stock

= 25% ( 5/20 x 100) x 5% + 15% x 9% + 60% x 16%

= .25 x .05 + .15 x .09 + .6 x .16

= .0125 + .0135 + .096

= .122 ( multiplying by 100 to make it in percentage)

= 12.2%

Answer 2

a) WACC = 12.20%

Step-by-step explanation:

Weighted average cost of capital is computed by allocating weights to different capitals.

Cost of bonds = Cost of debt = 5%

Cost of preferred stock = 9%

Cost of equity = 16%

As it is new issued and not from retained earnings.

With weights cost will be as follows

Bonds = 5% X $5/$20 = 1.25%

Preference share = 9% X $3/$20 = 1.35%

Equity = 16% X $12/$20 = 9.6%

WACC = 1.25 + 1.35 + 9.6 = 12.20%