Question

Quantitative Problem: Barton Industries expects that its target capital structure for raising funds in the future for its capital budget will consist of 40% debt, 5% preferred stock, and 55% common equity. Note that the firm's marginal tax rate is 25%. Assume that the firm's cost of debt, rd, is 9.0%, the firm's cost of preferred stock, rp, is 8.2% and the firm's cost of equity is 11.6% for old equity, rs, and 11.9% for new equity, re. What is the firm's weighted average cost of capital (WACC1) if it uses retained earnings as its source of common equity

Answer 1

Answer: 9.49%

Step-by-step explanation:

Formula for WACC:

WACC = (Cost of Equity * Weight of equity) + [(Cost of debt * weight of debt) * (1 - tax rate)] + (Cost of Preference share * weight of preference share).

As we are using retained earnings, this is not a new stock issue so the relevant cost of equity to use is the old one.

WACC = (11.6% * 55%) + [(9% * 40%) * (1 - 25%)] + (8.2% * 5%)

= 9.49%