Question

the color box uses a combination of common stock, preferred stock, and debt financing. the company wants preferred stock to represent 7 percent of the total financing. it also wants to structure the firm in a manner that will produce a weighted average cost of capital of 9.5 percent. the aftertax cost of debt is 4.8 percent, the cost of preferred is 8.9 percent, and the cost of common stock is 14.7 percent. what percentage of the firm's capital funding should be debt financing?

Answer 1

Approximately 48.2% of the firm's capital funding should be debt financing.

Step-by-step explanation:

The percentage of the firm's capital funding that should be debt financing can be calculated using the weighted average cost of capital (WACC) formula. The formula for WACC is:

WACC = (% of debt financing * cost of debt) + (% of preferred stock * cost of preferred stock) + (% of common stock * cost of common stock)

Using the given information, we can solve for the percentage of debt financing:

0.095 = (x * 0.048) + (0.07 * 0.089) + (1 - x - 0.07) * 0.147

Simplifying the equation, we get:

0.095 = 0.048x + 0.00623 + 0.147 - 0.147x - 0.01029

Combining like terms, we get:

0.095 = -0.099x + 0.14271

0.099x = 0.04771

x = 0.482

Therefore, approximately 48.2% of the firm's capital funding should be debt financing.